US dollar strength to continue amid stock market volatility

Risk markets have been hit hard from all corners as the US dollar continued its rampant run this month.

The US Dollar Index, a measure of the value of the greenback against a weighted basket of major currencies, has gained more than 4 per cent in September alone.

Judging by the current fundamental undertows, the next medium-strong resistance looks set to kick in at 120 levels, which were last seen in February 2002.

These fundamental parameters have remained unchanged over the course of the summer, as naggingly high inflation around the world sparks central banks to enter rate-increasing cycles that are becoming more aggressive with each meeting.

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Watch: US Federal Reserve chief warns of 'pain' in reducing inflation

The Federal Open Market Committee (FOMC) meeting this month all but confirmed it. While the US Federal Reserve delivered a 75 basis point increase, it was its target interest rate expectations over the next year that riled markets.

It was the third such increase of 75 bps by the Fed and the hawkish dot plot further riled foreign exchange and equity markets.

The dot plot, a key indicator for future Fed policy, showed that the FOMC increased its forecast for the main rate to be in the channel between 4 per cent and 4.5 per cent by the end of this year — and 4.6 per cent in 2023 versus the previously expected 3.8 per cent.

With two remaining FOMC meetings in 2022, this means that markets are pricing in a rate rise of 75 bps in November and another 25 bps in December.

Fed chairman James Powell was quite hawkish in his comments this month. He said unemployment would rise next year and the US economy would all but avoid a softer landing as a result.

The dollar kicked off in the aftermath of the news and Treasury yields also rose, with the two-year yield hitting 4 per cent for the first time since 2007.

Equity markets entered sell-off mode and continue to remain under pressure as a result of these developments.

The current environment will continue to see pressure on equity markets. As a result of higher rates, companies in the process of deleveraging will only exacerbate the downside moves in stocks, particularly high growth and technology shares.

Technically, the S&P 500 will hold above 3,617 levels to see out September, but I expect a move towards 3,300 through October.

Once again, the coming data points on the US economic calendar will be critical to reinforcing the existing trends. Weaker US data will yield higher Treasuries and higher dollar rates and put pressure on stocks and vice versa.

I will be watching the US home sales data when it comes out — higher interest rates will rile mortgage markets, which will then filter into a susceptible housing market that has, until recently, been booming.

The release of US gross domestic product data on Thursday is expected to show quarter-on-quarter growth at minus 0.6 per cent. The core Personal Consumption Expenditures (PCE) Price Index, which will be released on Friday, could spark additional volatility to see out the end of the week.

The core PCE Price Index is a key measure of US inflation, and measures the changes in the price of consumable goods, excluding food and energy.

Looking at the calendar through the start of October, US manufacturing data is released on Monday and the US unemployment report for September is due out on Friday, October 7.

Amid these critical releases, keep an eye on the numbers and brace yourself for additional weakness going forward.

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Cost of living crisis in the UK — in pictures

We had the Bank of Japan last week intervening in foreign exchange markets in its first such action since 1998.

In an effort to shore up the yen, the BOJ has clearly defined 146 as the level it intends to protect. Following this, I expect USD/JPY to continue consolidating in the range between 142 and 146.

And finally, the British pound is in the midst of one of its biggest slides on record.

At the time of writing, GBP/USD slipped by more than 7 per cent on the month and hit a low of 1.0360.

The combination of deteriorating UK fundamentals and a less active Bank of England — coupled with the announcement of Chancellor of the Exchequer Kwasi Kwarteng's fiscal plans, including sweeping tax cuts, last Friday — have slammed sterling's prospects.

Technically, the picture for GBP/USD continues to look very bearish and despite some intraday relief, I expect the pair to make a strong re-test of 1.05 levels, with another stronger move to 1.0360 in October.