Softer post-FOMC US dollar continues

US dollar retreats after FOMC

The US dollar fell after the FOMC meeting as investors priced in lower longer-term inflation expectations thanks to a pro-active FOMC. Longer-dated yields continue to trade on the softer side, although volatility remains at the shorter end of the curve. There is also likely to be some end-of-year book-squaring flows that will weigh on the greenback over the next two weeks. It will be interesting to see if we get the usual squeeze on overnight offshore dollar funding rates over the New Year turn this year, which should be greenback supportive next week.

Also weighing on sentiment is the failure of the Biden Build Back Better Bill to make it through the US Congress this year, if it ever does. Technically, that should mean less government borrowing, and less upward pressure on US bond yields and thus, less upward pressure on the US dollar. Risk sentiment is also steadier in currency versus equity markets right now, particularly regarding omicron. Currency markets are pricing in no virus dip from the new variant, most notable in strength in Asian EM and the commonwealths.

The dollar index fell sharply again overnight by 0.34% to 96.00, easing to 95.92 in Asia. Support at 95.50 could well be tested into the year-end, and I would not be surprised to see that continue into January before the FOMC monetary reality hits markets. EUR/USD rose sharply overnight to 1.1340 after a taper, not taper, announcement from the ECB. The rally remains asthmatic though, unable to reclaim 1.1350, and the euro, along with the yen, remain highly vulnerable to US dollar strength and rate differentials going forward.

A 10 basis point hike from the Bank of England overnight has lifted GBP/USD to 1.3330 today with the street pricing in future hikes after yesterday’s surprise. However, until we close above 1.3500, sterling remains in a technical downtrend and the UK could yet suffer an omicron upset. AUD, CAD and NZD all outperformed overnight thanks to steady risk sentiment, much like Asian FX.

Asian currencies have had a mixed performance. The yuan continues to strengthen despite weaker fixes from the PBOC. With China’s borders likely closed for all of 2022, the trade surplus flows will continue underpinning yuan strength. The SGD, THB, PHP, and IDR have all performed well post-FOMC, most likely because omicron has been discounted as a risk factor by investors. Although the INR and KRW have failed to rally, they are still holding steady. Both currencies are likely to feel the heat of fast-money outflows into the year-end, limiting gains.

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