US: Disappointing data & dovish speech from Fed Chair Yellen – MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the US dollar has continued to trade on a stronger footing in the Asian trading session coming off the back of its largest weekly gain since late in February.

Key Quotes

“The US dollar is deriving support both from positive domestic factors and negative developments in the near-term which are increasing its relative attractiveness. Market participants remain confident that the Fed plans to resume rate hikes in December unless there is a negative shock or economic surprise. The latest FOMC minutes signalled that the Fed is relatively close to resuming rate hikes.

Recent economic data flow from the US has been disappointing on balance but not yet sufficient to more seriously undermine market expectations for a December rate hike. The latest retail sales report and University of Michigan consumer confidence survey were both consistent with softer consumption growth. Control retail sales expanded weakly by 0.1% in September lowering the three-month average annualized rate of growth to just 0.3% down sharply from an expansion of 6.9% in June. There has clearly been payback weakness in Q3 after very robust growth in Q2. The weaker than expected retail sales report has resulted in further downward revision to estimates for GDP growth in Q3.

The Atlanta Fed’s latest estimate is that the economy has expanded by just under 2.0% in Q3 which would represent only a modest strengthening after expanding by 1.4% in Q2. More worrying was the decline in consumer confidence evident in the University of Michigan’s latest survey which likely responded to higher gasoline prices. Their expectations component of consumer confidence declined to a 26-month low in October. If sustained it is consistent with below trend consumer spending. Overall, both reports highlight a December rate hike although likely is not yet a done deal which should help dampen scope for further US dollar upside in the near-term.

The Fed has also been displaying some dovish signals recently reinforcing our perception that even if it resumes raising rates in December it is unlikely to be in a hurry to follow up the hike during next year. In a speech on Friday, Fed Chair Yellen provided a further hint that she has some sympathy for the view that allowing the economy to run a little hot for a while could help to reverse damage done to the supply side of the economy during the recession and slow recovery. She saw plausible ways that temporarily running a “high pressure economy” might encourage business investment, draw in additional potential workers and perhaps prompt higher levels of research and new firm start-ups. However, she judged that the benefits are hard to quantify and that the costs in terms of higher inflation and financial stability could exceed the benefits. It fits with our view that the Fed is unlikely to raise rates more than twice next year even as inflation pressures continue to build as was evident again in the latest PPI report. The annual rate of core producer price inflation accelerated to 1.5% in September reaching its highest level since November 2014.”

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