The US Treasury Serves as a Refuge

The macro point

US consumer prices increased by 3.7% year-on-year in September, compared to 3.4% in August. Yet, the dollar fell: at the ECB’s reference rate, the euro was worth 1.1253 dollars on Friday, up 0.42% for the week. This decline in the dollar is due to the Fed's interpretation of this inflation and, likely, the retreat of tech stocks.

First explanation: Gasoline, up 9.1% monthly, accounts for over half of the month's inflation. Excluding energy and food, the increase is 2.6% year-on-year and 0.3% monthly, above consensus, but ten-year market-anticipated inflation remains stable. The Fed can therefore delay raising its rates again, waiting to ensure this price increase doesn't affect other prices.

Investors initially considered a monetary tightening: according to federal funds futures, the probability of a rate hike in October neared 50% on Wednesday. However, several Fed officials deemed this tightening non-urgent, and its president, Kevin Warsh, refused to anticipate the October decision on Friday. This probability then dropped to around 15%. Thus, anticipated rate levels fell, and inflation did not support the dollar.

Second explanation: the decline of tech stocks. The Nasdaq lost 4.5% over the week, and distrust spread to the debt financing data centers. US government bonds served as a refuge: their ten-year real yield lost 13 basis points. The dollar did not play this role: as this decline is American, foreign investors could sell dollars forward to hedge their US assets.

Oil, which the US exports, did not support the dollar either, despite the Brent's 4.9% weekly rise. An expensive barrel worsens European trade terms but supports the expectation of a December ECB rate hike, favorable to the euro. According to us, the dollar may still fall if credit tensions remain American and if the Fed maintains its rates on October 28. Conversely, a global credit crisis would make it rise.

Technical point

Other euro rates confirm a dollar-specific decline: over the week, the single currency fell by 0.44% against the Swiss franc and by 0.45% against the pound. Monday morning, the euro is falling on all monitored pairs, probably penalized by the violence in France: 1.1225 dollars, 0.8421 pounds, 0.9253 francs, 1.5847 Canadian dollars, and 177.47 yen.

Four central banks set their rates next week: the Fed and the Bank of Canada on October 28, the ECB on the 29th, the Bank of Japan on the 30th. The status quo prevails: futures contracts give an 84% chance of the Fed maintaining rates, and 70 out of 73 economists surveyed by Reuters expect unchanged ECB rates. A surprise Fed rate hike would therefore make the dollar rebound.

According to us, the EUR/USD should move this week between 1.1105 and 1.1350. The bottom of this range would be reached if French government bond yields rise before Moody’s reviews France's rating; the top if US credit tensions worsen without spreading worldwide. Moving out of this range would signal a broader move than these two scenarios.

The supports and resistances listed below indicate the respective lows and highs within which courses should evolve during the week.

Announcements to follow

Today, Canadian inflation for September is expected to be 3.2% year-on-year (Reuters consensus), nine days before the Bank of Canada’s monetary decision. On Wednesday, UK inflation will shed light on the spread of energy price increases to other prices. On Friday, the flash PMI indices for October will gauge eurozone activity, then Moody’s will review France's sovereign rating under a negative outlook. A downgrade would weigh on the euro by widening the yield gap between French and German bonds.

Below you will find publications and events that should have a major impact on the evolution of exchange rates.

The information presented in this publication is provided purely for informational purposes and does not constitute investment advice, an offer to sell, or a solicitation to buy, and should not be used as a basis or considered an inducement to engage in any investment.