Dollar remains on the defensive after the FOMC

Overview: The dollar was sold in response to yesterday's FOMC decision. There has been limited follow-through selling in Asia and Europe today. The greenback is mixed as North American participants return. The Swiss franc is the strongest after the central bank left its key policy rate and zero and reaffirmed a high bar to a return to negative rates. On the other hand, the disappointing Australian labor report encouraged the market to push out the first hike next year and the Australian dollar fell amid profit-taking. Emerging market currencies are mixed. The PBOC set the dollar's reference rate at a new low since last October, and both the on- and offshore yuan extended their gains. 

Most of the large Asian-Pacific equity markets were sold, and perhaps there is a spillover effect of Oracle's disappointing results. The notable exceptions in the region were Australia, New Zealand, Singapore, and India. Europe's Stoxx 600 is posting a small gain, extending yesterday's gain. The S&P futures are off by about 0.5% and the Nasdaq futures are off around 0.7%. Australia's 10-year yield tumbled nine basis points after the poor jobs data, and the 10-year JGB yield slipped by 2 bp. European 10-year benchmark yields are narrowly mixed, while the 10-year US Treasury yield, which was flirting with 4.20% yesterday is little changed near 4.14%. Gold is hovering in its recent range, though so far today, it is holding above $4200. January WTI is heavy and reached a new low for the month near $57.50 today. Last month's low was closer to $57.10. 

USD: The outcome of the Federal Reserve meeting injected some volatility into the Dollar Index. It pushed through the lower end of the four-day range of roughly 98.75- 99.30. Yesterday's losses have been extended marginally today to almost 98.50. The next technical target may be around 98.30, where the (50%) retracement of the rally that began with the September 17 rate cut. Below there, the (61.8%) retracement is around 97.80. The Fed delivered the hawkish cut as many anticipated in that next year's GDP projections were revised up and the median "dot" remained for one cut in 2026 where it was in September. The main difference in the voting came as Chicago Fed President Goolsbee joined Kansas City Fed President Schmid to dissent in favor of standing pat, while Governor Moran persists in his dissent in favor of a 50 bp cut. However, there was a dovish surprise in the terms of Fed announcing $40 bln bill purchases from reserve management purposes, completely distinct, the Fed argues, from the conduct of monetary policy proper. Weekly US jobless claims likely bounced back after the holiday-distorted decline in the week of Thanksgiving. September trade figures may draw more attention given the tariff regime. Through August, the US recorded an average monthly deficit of $89.2 bln. In the eight months of 2024, the average monthly deficit was $71.4 bln. Exports have risen by an average of 0.5% a month this year compared with 0.7% in the January-August 2024 period. In the three months through August, exports rose by an average 0.7% a month. The average, in the three months through August 2024, exports rose nearly twice as fast (1.3% average per month). Imports have fallen by an average a month through August and rose by 0.8% on average in the same 2024 period. In three months through August US imports fell by an average of 0.9% a month after rising by 0.7% on average in the comparable 2024 period.

EURO: The euro was taken to $1.1700 after the FOMC meeting, its best level since October 17. It met the (50%) retracement of the losses since the year's high (recorded September 17). In early Asia Pacific trading today, it reached almost $1.1710 before a light bout of profit-taking pushed to about $1.1680. The euro retested the highs in early European turnover and is now consolidating. The October 17 high was almost $1.1730. The next retracement (61.8%) is near $1.1750. The eurozone economic calendar is light until Monday's October aggregate industrial production report. The highlight next week is the ECB meeting. It will do nothing, but it is one time that what it says is more important than what it does. The swaps market is pricing a small bias toward a hike late next year, and ECB President Lagarde's recent comments seemed to validate it. Yet, at the same time the 17-30 bp increase in the two-year yields among most members may induce counter-productive premature tightening. Separately, the Swiss National Bank left its key deposit rate at zero. It did reduce its inflation projections to 0.3% in 2026 from 0.5% and 0.6% in 2027 from 0.7%. The growth forecast was tweaked up to 1% next year from slightly under. The euro reached a three-month high against the Swiss franc on Monday (~CHF0.9395) and is now testing last week's lows (~CHF0.9325). The bar to a return to a negative policy rate is high. 

CNY: Over the past 30 sessions, the correlation of changes in the Dollar Index and the dollar against the offshore yuan is a little below 0.65, but still in the upper end of this year's range. If Beijing wants to slow the yuan's recent appreciation, the greenback's sell-off following the FOMC meeting, makes it more challenging. So far, here in December, the dollar has been bouncing along a CNH7.0540-CNH7.0770 range. The dollar approached CNH7.0575 yesterday and made a marginal new low for the year today near CNH7.0530. The PBOC has set the dollar's reference rate between CNY7.0733-CNY7.0794 this month. Last month's fixes were between CNY7.0779 and CNY7.0905. Today's fix was set at a new low CNY7.0686, which was about 0.09 lower than yesterday, the largest reduction in nearly three months. The dollar fell to about CNY7.0573, a new low since October 2024. 

JPY:   The drop in US rates following the FOMC meeting and the broad dollar selloff saw the greenback sold to JPY155.80, nearly reversing Tuesday's gains. It has approached the upper end of a band of support seen in JPY155.35-50 area. The lower end of that range corresponds to a (61.8%) retracement of the bounce from last week's low near JPY154.35. A common narrative is that higher Japanese rates will induce Japanese more of their savings at home and drive up global rates. Yet, over the past month, as Japan's 10-year yield has risen 24 bp, the 10-year Treasury yield has risen by about two basis points and European benchmarks yields have risen mostly by 10-20 bp. Over the past week, JGBs have performed best among the G10, with the yield slipping marginally lower. There are two important considerations. First, Japan runs a current account surplus. If it does not recycle that surplus and the foreign portfolio capital inflows, the yen would strengthen. Since the yen has fallen, it means that recycling regime is still robust. Second, the rise in other yields is more a reflection of shifting policy expectations with many G10 countries indicating that the easing cycle is over and the markets are discounting rate hikes next year in many high-income countries.

GBP: Sterling advanced to almost $1.3390 yesterday, its best level since October 22. Tuesday's bearish outside down day proved for nought. It edged slightly closer to $1.3400, which corresponds to the (50%) retracement of the decline since the year's high was recorded on July 1 (~$1.3790). A convincing break of $1.3400 targets $1.3450 next. It found support in early European turnover near $1.3755. The Bank of England is the other G10 central bank alongside the Federal Reserve that has not completed its easing cycle. The swaps market is confident (~90%) that the Bank of England will deliver a quarter-point cut next week. There is one more cut fully discounted next year, and the market has a roughly 40% chance it takes place in Q1 26 and nearly 100% chance it takes place in H1 26. 

CAD: As anticipated, the Bank of Canada left its policy rate steady. The tone was neutral, and the Canadian dollar chopped around. However, after the FOMC meeting, the greenback was sold broadly and fell to almost CAD1.3785. It posted an outside down day. The US dollar is consolidating in the lower end of yesterday's range and has held below CAD1.3825. The (61.8%) retracement of the US dollar's rally since the low for the year was set in mid-June (~CAD1.3540) comes in around CAD1.3770. A break of that targets the CAD1.3725-30 area next. Canada reports its September merchandise trade balance today. The US tariffs have had a clear impact on Canada. Its merchandise trade deficit widened to an average of -C$3.65 bln a month through August compared with a monthly shortfall in the first eight months of 2024 of -C$0.645 bln. In the three months through August, Canada's merchandise trade deficit averaged -C$5.25 bln after less than -C$0.9 bln in the same 2024 period last year.

AUD: The US dollar's sell-off after the FOMC meeting lifted the Australian dollar through is recent nemesis near $0.6650. It reached a little above $0.6685 to close in on the year's high set September 17 (~$0.6705). Above there, there is little on the charts until closer to $0.6800. However, disappointing November employment figures encouraged profit-taking that pushed the Aussie back to Australia reported November jobs data earlier today. It lost a little more than 21k jobs whereas the median forecast in Bloomberg's survey was for a gain of 20k. It lost 56.5k full-time jobs, slightly more than were gained in the previous month. The Australian labor market has slowed this year and does not show signs of strengthening. The average monthly job creation this year is around half of last year's pace and full-time posts growth lagged by a little more. The unemployment rate stood at 3.9% in November 2024 and is now at 4.3%. It had been at 4.3% since June except for jumping to 4.5% in September. The participation rate was slipped to 66.7% from 66.9%. In November 2024, it was at 66.9%. After nine sessions of increasing the chances of a hike by mid-2026, the futures market shaved the odds to about 87% from a small bias toward 50 bp yesterday. 

MXN: The dollar slid against the peso after the FOMC meeting. It approached but could not take out the year's low set last week near MXN18.1525. Yesterday's sell-off stalled around MXN18.1575. It is consolidating in a roughly MXN18.1560-MXN18.2235 range so far today. The central bank issues its report on the regional economies today, which tends not to move the markets. On the other hand, tomorrow, Mexico reports October industrial production. The median forecast in Bloomberg's survey is for a 0.1% gain. While it does not sound noteworthy, consider it would be the first gain in five months. That coupled with the higher November inflation reading reported on Tuesday may be sufficient for Banxico to signal a pause after next week's rate cut. On the other hand, the Brazilian real was one of the few currencies that the greenback remained resilient against yesterday. It set nearly a two-month high on Tuesday near BRL5.4950 and held a little below there yesterday. Yet, the dollar still posted its highest close since mid-October. Although the real settled weaker yesterday, the central bank dampened expectations of a rate early next year by explicitly declaring that holding rates at their current level for a "very prolonged period" is necessary for inflation to converge with the target but acknowledged the high degree of uncertainty.