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U.S. Dollar Rally: Fed Policy Shifts and Election Speculation Drive Market Surge

Fed Policy Shift and Trump Victory Odds Propel Dollar Rally 


Since the beginning of the month, the U.S. dollar has gained more than 3% against a basket of major currencies, reaching its highest levels since late July. This surge has been fueled by two main sources: the U.S. elections and shifting expectations regarding the Federal Reserve's policy path. 


According to calculations by Standard Chartered Plc, 60% of the dollar’s October gains are attributed to increasing bets that Donald Trump could win the election. Although recent polls indicate that the candidates are statistically almost tied, some betting markets reflect growing speculation that Trump may prevail, with odds estimating a Trump victory at around 60-70%. 


Trump’s emphasis on higher tariffs and the potential market volatility associated with this stance is driving a flight to quality. Additionally, markets expect tariff policies could lead to higher inflation, weakening the Fed’s hand in further lowering rates. 


While election uncertainty has been a primary driver of the dollar’s recent rally, Standard Chartered Plc estimates it only explains 7 basis points of the 40 basis point rise in 10-year U.S. Treasury yields. Most of the pricing originated from the Fed's policy outlook shift. The jobs report released at the beginning of the month helped unwind pricing tied to exaggerated recession fears. Recent data has pointed to a strong U.S. labor market and economic growth and inflation exceeding expectations, reducing the pace of anticipated rate cuts. 


Yesterday, the October preliminary reading of the Purchasing Managers’ Index (PMI) published by S&P Global revealed that U.S. business activity expanded steadily in October, supporting growth expectations. The composite PMI rose by 0.3 points to 54.3, despite three consecutive months of declining factory output. 


The expected output index for next year rose by 8 points, reaching its highest level since May 2022. This suggests that U.S. companies wait for the election to pass before increasing business spending. 


On the other hand, new orders surged to a one-and-a-half-year high, emphasizing strong demand, while growth in both production and sales was confined to the service sector. Meanwhile, the composite price index fell to its lowest level in over four years. This suggests that competitive pricing may be lowering sales price inflation. Lastly, the composite employment index contracted for the third month, sitting just below the equilibrium level, which could indicate that employers are deferring hiring decisions until after the election. 


A few hours before the PMI data, weekly initial jobless claims fell for the second consecutive week, returning to levels seen before hurricanes struck Southeastern states. Claims dropped by 15,000 to 227,000 in the week ending October 18, while economists surveyed by Bloomberg had expected 242,000 claims. 


Continued claims, which indicate the number of people receiving benefits, exceeded expectations, reaching 1.897 million in the week ending October 11, marking the highest level in nearly three years. Some market observers suggest this reflects the impact of hurricanes and ongoing worker strikes. However, the increase in continued claims typically indicates greater difficulty in finding employment. As a result, risks to the labor market have once again come into focus ahead of next week’s critical payroll data, putting some pressure on the U.S. dollar. 


As expectations for the Fed remain a key driver of dollar pricing, next week’s data releases could serve as potential catalysts. Preliminary third-quarter GDP growth estimates and September readings of the Personal Consumption Expenditures (PCE) price index, the Fed’s preferred inflation gauge, are due for release. Capping the week, the October non-farm payrolls report will be watched on Friday. 


After the September report reversed expectations regarding the Fed’s rate path, whether October figures confirm the labor market's strength is critical for Fed projections. The labor figures that meet expectations could support a slower rate-cut trajectory, potentially strengthening the dollar; however, further cooling in the labor market would likely be negative for the dollar. Nevertheless, the decisive factor will be the overall picture presented by labor data in conjunction with inflation figures. 



Gold Rally Eases on Profit-Taking; Fed Rate Path and Uncertainties Shape Outlook 


Gold prices rose approximately 1.5% this week, reaching a new all-time high of $2,758 per ounce, before pulling back slightly amid profit-taking.  


Precious metals benefit from strong safe-haven demand driven by uncertainty around the U.. elections. Even the surge in U.S. Treasury yields to three-month highs couldn't halt this week’s rally. Yields jumped above 4% on rising bets that inflation could increase post-election in the U.S. and that the Fed might adopt a slower pace of rate cuts. The 2-year yield, which was at 3.61% on October 1, has now risen to 4.05%, while the 10-year benchmark yield has increased from 3.74% to 4.18%. 


In the current environment, high yields are exerting pressure on precious metals. However, major central banks beginning easing cycles, ongoing geopolitical risks, and strong central bank purchases maintain a positive outlook for gold. 



ECB Faces Rate Cut Debate as Economic Stagnation Fuels Aggressive Policy Calls 


Following the European Central Bank's (ECB) third rate cut of the year last week, discussions are underway regarding the December meeting. Recent inflation data falling below the bank's 2% target and continued stagnation in the region’s economic activity have raised expectations for more rapid rate cuts. 


In the final stretch, statements from ECB policymakers indicate a divergence of views on the pace of cuts. Some more dovish officials emphasize the need for steeper rate cuts, while their more hawkish counterparts urge caution.  


Meanwhile, business activity in the Eurozone continued to contract this month. PMI data released yesterday revealed that the downturn in Germany, the region’s largest economy, has slowed, while the contraction in France, the second-largest economy, has deepened. This situation intensifies expectations for more aggressive cuts from the ECB. 


Futures market data indicates that a half-point rate cut for December is priced in with a 50% probability, putting pressure on the euro, the region’s common currency. For further cues, markets will closely watch the Eurozone’s third-quarter GDP and preliminary October inflation readings next week. 



Japanese Yen Under Pressure as BOJ and Election Uncertainties Weigh 


The Japanese yen continues to weaken, impacted by both the strengthening U.S. dollar and the Bank of Japan's (BoJ) retreat from its hawkish stance.  


Shigeru Ishiba, elected last month as the new leader of the ruling Liberal Democratic Party (LDP), did not support rate hikes, contrary to expectations. Since then, Japanese stocks and the yen have remained under pressure, with upcoming general elections this weekend posing a risk of extending this trend. 


Japan’s ruling coalition faces the threat of losing its majority in the lower house of parliament for the first time since 2009. Market observers predict such a result would increase pressure on the yen and stock market. In the event of a government change, uncertainty around the direction of monetary policy could rise. 


Ishiba cited lingering deflation concerns as the reason for not backing rate hikes. On the other hand, markets have been speculating on whether the yen’s recent depreciation might push inflationary risks upward, prompting an earlier-than-expected rate hike. However, BoJ Governor Kazuo Ueda recently signaled that despite the yen falling to a three-month low, interest rates would not be raised at the upcoming October 31 meeting.  


Ueda stated his belief that there is sufficient time to make a policy decision, stressing the need to carefully examine how U.S. economic developments might affect Japan’s inflation, potentially in connection with the U.S. presidential elections. This statement implies that the BoJ may want to observe the outcomes of the U.S. elections before taking any policy action. 


Earlier today, Tokyo’s consumer price report showed a decline to 1.8% in October from the previous 2.1%, marking the first drop below 2% in five months, largely driven by falling energy prices. While today’s data are not expected to influence the BoJ's decision next week, it is evident that they will not reinforce the BoJ’s view of economic stability. 


All 53 economists surveyed by Bloomberg expect no action at next week’s meeting. Additionally, 53% of respondents foresee a rate hike in December, while the proportion betting on a January hike has risen to 32% from 19% amid recent developments. As expectations for rate hikes are deferred, selling pressure on the yen may intensify.

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