Australian dollar calm before the storm

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Stocks paused:

DXY rebounded with US consumer confidence but the US dollar is fighting a losing battle as that economy leads developed market disinflation. Goldman looks right to me:

USD: There’s more where that came from. The Dollar sold off sharply in response to cooler inflation and anticipation of a more patient Fed stance beyond July. We think this can extend in the near term because the same factors that weighed on this report look likely to be softer still in coming months, and the policy implications bring welcome relief to a number of corners of the market. We think the Dollar’s selloff is justified (Exhibit 1). And the rank order of performance looks to us like a mix of fundamental factors—a safer carry environment, less policy divergence from rates-sensitive currencies, clearer divergence where the domestic inflation picture is still challenging—and technical factors, including positioning and rotating funders into USD. Now, that gets to be quite a long list of currencies that understandably benefit from a softer Dollar and narrower distribution of policy rates. But we still maintain that overall Dollar depreciation over the course of this year is likely to be shallow and subdued, with more bumps down the road. This is partly because we maintain that the outlook is not that divergent for a big part of the broad Dollar index—policymakers across much of EM are already responding to lower inflation, and the Euro area should not be far behind.

That is not how markets traded this week, with US rates mostly moving in isolation. As we noted earlier this week, Euro area rates appear to be responding more to hawkish rhetoric than incoming data, unlike in the US and UK, and that seems less durable. Second, despite the weaker near-term inflation outlook, US policymakers will still need to be vigilant because inflation remains above target and the economy has been firmer than Fed officials expected. The NFIB and University of Michigan surveys this week served as reminders that underlying momentum remains strong, and that could have inflationary implications—more firms plan to raise prices over the next three months and households reported better net sentiment on their personal finances than at any time over the last two years. Third, for the broad Dollar to move much lower, CNY will need to participate. But policymakers there are dealing with low inflation of a different order of magnitude and are still in easing mode. The fact that China policy had previously been leaning against Dollar appreciation now means less room for it to fall. Indeed, spot rates have now moved back below our 3m 7.20 forecast, and we think the scope for much further CNY appreciation is still limited. Relatedly the broad Dollar should still benefit from important buffers including relatively high carry and safe-haven demand set against still-subdued capital return prospects in the Euro area and China, which account for a large portion of the overall index.

Therefore, we still do not think this will be a trending FX market (in spot terms) over the medium term and the market has already taken a lot of credit for the weaker inflation data.

DXY has further to fall but not overly far and as Chinese economic circumstances deteriorate, both CNY and EUR will roll too.