USD Updates 1-Year High but Friday Correction Slashes Weekly Gain

The US dollar has had a relatively great start in November, although it corrected on Friday and slashed the weekly gain that was still on track earlier that day. The most defining events were the Federal Reserve’s monetary policy update from Wednesday and the Labor Department’s Nonfarm Payrolls report that was released on Friday. 

The USD Index, which tracks the greenback against six other currencies, ended up with no change over the week, although it has managed to update the highest level in a year earlier on Friday, touching 94.5677, before correcting to 94.1937.

Last week, the index tumbled to the lowest since the end of September on disappointing GDP growth data, but it bounced back at the end of the week as investors started to price in an earlier-than-expected rate hike from the Fed, as the core personal consumption expenditures index, released on October 29, increased at annual 4.4% in September, the fastest in three decades.

The general mood about the USD has been bullish, but the last-minute correction spoiled the party.

As mentioned, the two most impactful events were the Fed’s decision and the jobs report – so let’s see how the US national currency reacted to these events:

Fed Starts Tapering in November

On Wednesday, the Fed said, following a two-day meeting, that it would start reducing its bond-buying later in November at a pace of $15 billion per month. Investors have already priced in this decision, which has been the main driver behind the USD’s rally to its highest level in a year in October. However, the fact that tapering hasn’t been delayed for December was interpreted as a hawkish signal from the central bank. 

Speaking about the pace of reductions in bond-buying, the Federal Open Market Committee (FOMC) said in a statement that following the $15 billion cuts this and next month, “the committee judges that similar reductions in the pace of net asset purchases will likely be appropriate each month, but it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook.” 

Specifically, the Fed would reduce Treasury purchases by $10 billion per month and mortgage-backed securities by $5 billion per month, gradually withdrawing from a program meant to support the economy during the COVID-19 pandemic. 

Since the program started, the central bank has purchased $80 billion in Treasuries and $40 billion in mortgage-backed securities every month. The Fed’s balance sheet has surged to $8.6 trillion from $4.4 trillion during this period. Given that the US economy is set to expand in 2021 at the fastest rate in four decades, despite the latest disappointing GDP performance, the central bank considers that it no longer needs these supportive measures because keeping them for longer than needed can actually cause more harm. For instance, low mortgage rates created the conditions for an explosion in house prices.

Julia Coronado, a former Fed economist and president of economic advisory firm MacroPolicy Perspectives, told Reuters:

They are doing it because the economy is really strong… The economy can stand on its own.”

As for the interest rate decision, the Fed left the target range at zero to 0.25%, in line with expectations. Investors paid attention to the FOMC’s language, which has changed a bit compared to the last meeting. Specifically, while the Fed reiterated that the current high inflation was “transitory,” it admitted that global supply issues were adding to inflation risks. Basically, the central bank seems to have extended the meaning of “transitory” even though it’s not ready to give up using it. 

Fed Chairman Jerome Powell said that it was not the right time to start raising interest rates given that the jobs market had not fully healed. He stressed that it was possible that the labor market may have improved enough by mid-2022 to be considered at “maximum employment.”

Despite the Fed’s assurance that the jobs market doesn’t encourage higher interest rates, traders are betting on two rate hikes next year, which is well ahead of the Fed’s current projection for a single rate increase by late 2022 or early 2023.

The Fed and other central banks started to take inflation risks more seriously, as supply-chain issues cause shortages amid strong global demand. As we mentioned at the beginning of the post, the central bank’s preferred inflation measure came in at 4.4% in the 12 months to September, the highest in 30 years and more than double the Fed’s target. 

The US dollar reacted positively to the Fed’s decision to start the tapering later this month, increasing on Thursday against the euro, the pound, and the Japanese yen, among others. 

Nonfarm Payrolls Rose More than Expected 

On Friday, the US Labor Department reported that nonfarm payrolls rose by 531,000 in October, higher than the upwardly revised 312,000 jobs in September and exceeding projections anticipating on average 450,000 jobs for October. The official Nonfarm Payrolls report is released every first Friday of the month and is one of the most closely watched economic reports. 

The latest jobs data show that the economy is regaining momentum in the final quarter of 2021, as the number of COVID-19 cases has been declining. However, the labor force is still down 3 million compared to the period before the pandemic, and we quoted Powell as saying that employment will return to its maximum capacity by mid-2022. 

Brian Bethune, a professor of practice at Boston College, told Reuters:

The dog days of summer are long gone and the US economy is gearing up for an acceleration in growth and activity in the fourth quarter. Demand for labor is strong, but there is an issue with matching people with the jobs that are available.”

US President Joe Biden praised the upbeat data following two straight months of disappointing gains. He stressed that the country had to focus on vaccinations and keep COVID down for the economy to fully recover. 

The acceleration in the jobs market was led by leisure and hospitality, which added 164,000 jobs. Payrolls also increased in professional and business services, transportation and warehousing, healthcare, wholesale trade, financial activities, and mining sectors. Elsewhere, state and local government education lost 65,000 jobs. Overall government payrolls dropped by 73,000 jobs.

The upbeat jobs data, together with a better-than-expected increase in services sector activity and rising consumer confidence is pointing to a recovering economy, supporting the case for the US dollar. 

The unemployment rate declined to 4.6% from 4.8% in September, while analysts expected a 0.1% improvement only. 

Demand for workers has supported an acceleration in wage growth, with average hourly earnings adding 0.4%, which means an annual increase to 4.9% in October, from 4.6% in September. 

Shortly after the nonfarm payrolls data became public, the US dollar surged to the highest level in over a year. However, the greenback was forced to correct at the end of the trading day as risk appetite improved, leaving the door open for a rally in the stock market. 

The USD is regarded as a safe-haven currency, which is why it pulled back slightly amid improving risk appetite. 

What’s Next for the USD?

So far, the US dollar has had a great start to the month, with the USD Index managing to hold above the support level of a long-term bullish channel that began forming in June. 

Longer timeframes show that the USD Index is about to test a key resistance level near 94.600, after rallying since the end of May. Judging by the weekly chart, the index formed a double bottom pattern in Q4 last year and H1 of this year, and it remains to be seen whether it can go higher above the pattern’s neckline and break the key resistance. 

Next week, investors will keep an eye on inflation data scheduled for Wednesday. 

Interestingly, data from the Commodity Futures Trading Commission (CFTC) released on Friday showed that traders’ net long bets on the greenback fell to their lowest since September. Specifically, the value of the net long dollar position was $19.51 billion for the week ending November 2, down from $20.07 billion in the previous week. 

However, it’s worth mentioning that the bullish bets were reduced ahead of the Fed’s decision and the Nonfarm Payrolls report, both of which favored a stronger dollar. Shaun Osborne, chief FX strategist at Scotiabank, told Reuters that net long positioning was still significant, which “reflects solid bullish sentiment in the greenback as markets look to the beginning of the Fed’s hiking cycle.”

Year-to-date, the USD Index has gained about 4.7% and is set to go higher if the Fed gives up its dovish stance next year. 

EUR/USD is now trading at 1.1568 after declining to the lowest level since July 2020 at 1.1513. 

GBP/USD tumbled 1.40% for the week after the Bank of England surprisingly failed to increase the interest rate as expected by most investors. The pair continues to fluctuate inside a bearish channel that started to form at the end of May. 

We’ll keep you updated on USD’s next major moves! 

 

 

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