The dollar is slightly weaker in consolidative trade – BBH

Economists at Brown Brothers Harriman & Co. (BBH) suggest that the recent dovish turn by the Federal Reserve might continue to weigh on the US Dollar, though the fundamental backdrop favours bulls.

Key Quotes:

“DXY is trading near 105.15 but has held on to the bulk of yesterday’s gains. While we still believe the fundamental outlook favors the dollar, we acknowledge that near-term dollar weakness is likely to continue after Powell’s unexpected dovish turn.  If the U.S. data continue to come in firm like ISM services, that dovish Fed narrative could start to crack.”

“After Powell’s speech last week, the narrative swung towards dovish.  After AHE and services PMI, that narrative is swinging back to hawkish.  We imagine there will be some whispers about 75 bp from the Fed next week but we think it will depend in large part on the CPI data out the day before the decision. “

“That said, we think it was a mistake for Powell to take 75 bp off the table last week.  WIRP still suggests that a 50 bp hike on December 14 is fully priced in, with only 5% odds of a larger 75 bp move.  The swaps market is pricing in a peak policy rate of 5.0% but odds of a higher 5.25% peak have crept back in.”

“Both AHE and core PCE have flat-lined near 5% for most of this year despite falling CPI and PPI readings.  We believe that getting core PCE back down to the Fed’s target of 2% will be much more difficult than markets are pricing in.  We don't think two more 50 bp hikes will do it, not when the labor market remains so firm and consumption is holding up.”