Last week’s US disinflation shock altered the FX landscape, but a few days without key data releases will tell us whether that impulse can keep the dollar on the back foot as the FOMC risk event draws nearer.
The FX positioning landscape has undergone a radical shift since the US CPI and PPI releases last week, demanding a revaluation of the dollar’s outlook.
Unfortunately, the Commodity Futures Trading Commission (CFTC) data on speculative positioning provides little assistance in understanding the extent of the changes in dollar positioning since the latest reported positions were from Tuesday, before the inflation report. At that time, the weighted aggregate positioning against reported G9 currencies (G10 excluding SEK and NOK) had already dipped into net-short territory (-2% of open interest in my calculations).
Comparing it with the dollar decline in November-December 2022, there’s a crucial difference in positioning. By the end of October 2022, markets were still speculatively long on the dollar (around 10% of open interest against CFTC-reported G9). Another significant factor, particularly for EUR/USD, is the reduced potential for other central banks outside the US to surprise on the hawkish side compared to last autumn.
These considerations, despite the compelling bearish dollar narrative, suggest that FX movements might not be one-sided from here on, even if the dollar continues to weaken into year end. Fundamentally, the disinflation narrative benefits risk assets, promotes a re-steepening of the US yield curve, and makes pro-cyclical currencies more appealing. However, the US Federal Reserve might not pivot into a USD-negative stance abruptly.
US economists still see a 25bp hike next week as likely, though it’s already fully priced in. But will the Fed be willing to halt further rate hikes just yet? Core inflation is declining, but the job market remains tight, and other economic indicators show resilience. The dot plot indicates another hike before a peak, and Fed Chair Jerome Powell might prefer to err on the hawkish side, particularly in response to a rate cut pushback (with the first cut priced in for Q1 2024).
This week’s developments are worth monitoring as the absence of tier-one data in the US will offer clues on how FX markets will behave moving forward. The question is whether investors now have sufficient reasons to add short positions on the dollar ahead of the FOMC meeting or take a more cautious approach.
Market commentary and analysis from Luca Santos, currency analyst at ACY Securities
