The main theme of our updated G10 views is a moderately weaker US dollar, due to the US economy finally “catching down” to the rest of the G10.
A slower US economy and rapidly worsening survey data means the risks are tilted towards one FOMC rate cut in the next two quarters.
Our view is that this change will be sufficient to at least dampen the broad dollar strength seen for most of this year.
The Fed’s balance sheet expansion, although not “true QE”, will nonetheless represent an end to quantitative tightening and further blunt dollar strength. US data is once again showing a significant divergence between hard data such as that related to output and consumer spending, and survey data.
In many cases, we believe matching easing from other G10 central banks will offset the impact of the Fed’s actions, and keep the scale of the dollar’s losses relatively small.
US data is once again showing a significant divergence between hard data such as that related to output and consumer spending, and survey data. Much of this appears to be linked to the global manufacturing supply shock caused by Trump’s trade war.
There are reasons to believe that resilience in consumer spending will ultimately mean survey data will improve as the economy continues to grow – but the size of the negative shock to survey data is likely to keep the Fed on a defensive footing in Q4.
In particular, even if the economy remains in growth as hard data suggests, the Fed may be forced into more than one 25bp cut purely out of a desire to avoid tightening financial conditions, which are currently predicated on expectations of far more accommodative policy from the Fed over the next 12 months.
Based on incoming data…
The US economy does not appear to be heading towards a recession in the near future, and the labour market remains tight by historical standards.
Consumer confidence remains high, and real wage growth is likely to continue to support consumption. In this sense, the US may be entering a period of resilient consumption offset by poor business sentiment and investment.
This has similarities to the UK, New Zealand and Australia, where strong labour markets have supported consumption while business confidence has deteriorated significantly.
The trajectory and outcome of the US-China trade war is the key source of uncertainty for Q4.
A further escalation of tariffs seems unlikely from here and is not our base case expectation, due to the self-evident economic and political costs in the US. However, miscalculation from either side or another bout of erratic policymaking from the US could see tensions escalate further, significantly changing the outlook for G10 and EM FX.
Chart: Non-Farm payroll growth below 200,000 for fifth consecutive month as job creation slows