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USD: Equity divergence matters
US markets re-open after a long weekend today and futures currently point at a slightly positive open in the Dow Jones, despite yesterday’s slump in European equities. Diverging US-European equity performance is becoming a relevant theme for FX as a driver of USD strength: in our EUR/USD short-term fair value model, the relative equity performance factor has seen its beta grow steadily since the start of July. Indeed, the ongoing energy crisis does suggest that it will take time to restore trust in European assets. In the past three months, the Dow and S&P500 are both down -5%, while the DAX has lost 13% and Euro Stoxx 9%.
Expect a pick-up in volatility today after yesterday’s rather muted trading. On the data side, markets will focus on the US ISM Service index, which is expected to have dropped after July’s modest rebound. This is probably the most important piece of data before the CPI report on 13 September, and with markets still torn about the possibility of a 75bp Fed hike in two weeks (65bp is priced in), asset classes should prove quite sensitive to the release.
There are no scheduled Fed speakers today, but we’ll hear from a plethora of members tomorrow and from Fed Chair Jerome Powell on Thursday.
Barring a major dovish repricing in Fed rate expectations, the strong dollar story should remain broadly untouched this week, as the energy supply crisis keeps markets away from most European currencies and may fuel safe-haven flows further. As we’ve highlighted in recent notes, the yen’s role as a safe haven has been eroded by Japan’s worsening trade position, and the USD/JPY rally may have further to go until Japanese authorities intervene.
Elsewhere in the APAC region, AUD had a relatively contained reaction to the RBA’s 50bp rate hike. As highlighted in our meeting review, a switch to 25bp rate increases now looks possible given the high frequency of RBA meetings, although that may be read as a dovish signal by markets and force some dovish repricing along the AUD curve. This, however, is far from being the biggest concern for AUD, which is set to remain heavily impacted by a challenging external environment. We don’t expect any AUD/USD recovery to go much further than 0.70 before the end of the year.
Francesco Pesole
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