DXY has declined in eight of the past 10 Decembers (average: -91bp) but will this December be any different? Since 21st Nov, when New York Fed President Williams spoke about the space for cutting rates in near term, DXY has languished against major DM FX. DXY has fallen from 100.3 around 21st Nov to 99.45 levels currently. We were earlier of the view that Dec FOMC might be a hold because of lack of data but seeing the Willims comment and current market pricing which Fed might not want to surprise, we accept the possibility of a cut of 25 bps. But we still believe this will be a hawkish 25 bps cut stressing that the inflation gap matters more than the unemployment gap based on financial conditions being “loose” because equities are high and credit spreads are tight. It would stress that neutral is above 3%, that policy is only “modestly” restrictive and that future moves depend on “incoming data” rather than the clear deterioration already visible in labor market readings and credit access. Markets would read that as one-and-done or, at best, a much shallower future path of easing until new leadership/personnel is established. Front-end yields would stay elevated in real terms; the dollar would rally and the risk premium on equities and credit would need to rise to compensate for the Fed being behind the curve on labor markets. We like DXY long against EUR & JPY. We believe BOJ has enough reasons for hiking by 25 bps in it’s 19th Dec meeting due to sustained elevated inflation profile but it might wait till it’s 31st Jan meeting to see the Shunto wage negotiation results. In addition PM Takaichi expansionary policies might force Ueda to skip hike in the Dec meeting. We see JPY testing 160 in December as BOJ again fails to hike. We look for EUR to test 1.1475 levels in Dec as Fed does a hawkish cut & Russia Ukraine peace talks fail to come to it’s logical conclusion. Amongst DM FX, we are relatively bullish on GBP against EUR for the month of December. Short GBP positions had been popular going into the budget, and these are likely to see some unwinding on the avoidance of the major negatives. We like to sell EURGBP around .8800 and .8850 levels for an eventual fall to .8680 levels. We also like NZD & target .59 levels from the current .5735 levels. Following the hawkish RBNZ 25bp rate cut this week and further strong economic releases it appears that the market is swinging hard towards an upswing in NZD. To summarise, we believe sticky US inflation will likely limit the FOMC’s ability to give a neutral 25 bps cut in Dec policy. Hence even if there is a 25-bps cut, it will be accompanied by hawkish press conference from Fed Chair Powell. This will be the compromise which Powell might work out to reach a consensus though we still believe a rate hold can’t be ruled out. We also believe liquidity towards non dollar assets might be soon drying up due to elevated supply in better yielding investment grade dollar corporate bonds and this too should support DXY. US seems to be the cleanest shirt in town considering it’s relatively better growth profile than both EU & UK. Hence DXY rebound should get aided by growth differentials too.
