The Fed will temper the pace of rate hikes as traders bet the world's biggest economy is starting to slow, according to Bloomberg - A gauge of the dollar dropping to a three-week low.
The Bloomberg Dollar Spot Index fell as much as 0.9%, sliding along with benchmark Treasury yields for a second day. In 2023, the upper bound of the Fed's target range will peak at about 5%, compared to almost 5.20% last week.
The common currency has advancing past parity with the US dollar for the first time since Sept. 20 with the repricing benefiting the euro and the pound. The pound went up by 1.3% to $1.1620, the highest level in more than a month.
A slew of US data on manufacturing, home prices, and consumer confidence fell short of economist estimates, underscoring the toll of Fed tightening. The Federal Reserve officials have sounded cautious, with San Francisco Fed President Mary Daly saying last week that policy makers should start planning for a reduction in interest-rate increases.
We are probably on the last leg of the USD strength, said Themistoklis Fiotakis, head of FX research at Barclays Bank, in an interview on Wednesday. It's pretty clear that a lot of the components of the US economy are starting to show signs of peaking, whether it is wage growth, inflation growth or whether it is the housing market. The 10 year Treasury yield fell as much as 8 basis points to 4.02%, down from the month's high of 4.34%. The euro was 0.8% stronger at $1.0047 as of 10: 32 a.m. in London.
The market is at risk of a squeeze, with many investors still positioned for more dollar gains. According to Bloomberg CFTC non-commercial futures, bullish bets are around double the average over the last five years.
The dollar's slide is compounded by the bearish sentiment toward the pound and the euro shift. After former Chancellor of the Exchequer Rishi Sunak was appointed prime minister, the UK assets rallied, signalling an end to a planned expansive fiscal policy under Liz Truss that had plunged markets into turmoil.
The euro is strengthening after a decline in natural gas prices, which should improve the eurozone's terms of trade position, according to Chris Turner, ING Groep NV strategist. He said a break in parity could trigger a sharp short squeeze to $1.02 after a break of parity.
The options market is seeing a brighter outlook on the common currency, with one-week risk reversals for the euro-dollar pair trading at their least bearish levels since February. According to the data released by the CFTC, hedge funds have cut their euro-short exposure to the lowest since June.
How far this trend continues is going to be in part determined by the European Central Bank's meeting on Thursday and the Fed's rate decision next week. Ahead of that, traders will be watching for upcoming US data, including new home sales later Wednesday.
Markets haven't gotten much conviction and fuel to chase hawkish Fed trades right now, especially when you see warnings around over-tightening fears in housing data, said Viraj Patel, senior strategist at Vanda Research in London. We are starting to see 10 year yields drift lower. With assistance from Edward Bolingbrokes, James Hirai, Greg Ritchie, Vassilis Karamanis, Francine Lacqua, Naomi Tajitsu and Libby Cherry.
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