The US dollar has rallied to near 12-month highs since the turn of the month, driven by the Fed’s hawkish shift and ongoing uncertainty around the global recovery. But, while the global recovery is slowing, this attenuation is from an exceptionally fast pace. The big concern is China’s economy which is engulfed in a property and energy crisis, which will weigh on domestic GDP growth.
Catalysts to pay attention to as forward indicators of dollar’s trajectory:
1) The pace of the global recovery from here. For example, if China’s energy crunch were to worsen, energy costs will spike, production will weaken, it would add further pressure to already strained supply chains.
This could turn global trade growth negative, which often coincides with a stronger dollar, and weigh on the upcoming Q3 earnings season which kicks off today. The risk that these scenarios play out is increasing. In a nutshell, slowing global growth = strengthened dollar. In the near term, the upside pressure on the dollar from a weakened global economy will more than offset the dilutive effects from money printing.
2) Fed decisions. The Federal Open Market Committee will today release minutes from the September meeting. Investors will be parsing nuance from the minutes for potential clues as to the Fed’s plans to begin the taper. Investors expect an announcement in November, and for the process to take until mid 2022. A faster pace than this will strength the dollar, a slower pace or the existing course, will not add any further upside momentum to the dollar.
3) Inflation data. Markets are bracing for a U.S. CPI report today that is expected to show elevated inflation, providing more support to the case that inflation is enduring for longer. This issue is at the centre of a hot debate in markets: is US inflation transitory or permanent? Obviously, there are components of the two. The Fed argues much of the inflation we are experiencing (higher prices, labour costs, low production output, supply chains bottlenecks, etc) will unwind over time. But the Fed’s critics say: more of this inflation is permanent than you are acknowledging and the transitory inflation will also last for longer than you assume (headwinds from China add to this argument).
So far, there is evidence to support both cases and it will take until the end of the year before we decisively know. If the Fed is right, it will stay the course on its interest rate trajectory (markets expect four interest rate hikes by the Fed by the end of 2023). But, if the Fed’s critics are proven right, the Fed *may* accelerate interest rates faster than current trajectory which could spook markets and trigger a risk-off sentiment (negative for crypto). Thus, there is always a little anticipation these days around new inflation data releases. For now, the Fed is looking past the consequences of rising inflation.
For crypto, the impact from one data release is usually slim, but it is worth paying attention to these downside risks and remain cognisant of catalysts for larger changes in market sentiment for risk assets. For example, the IMF warned on Tuesday that sudden and steep declines in global equities prices and property prices were possible, as central banks withdraw unwind asset purchasing. The broader danger here is that “pockets of market exuberance and rising financial leverage” may start to unwind in disorderly ways as credit tightens, the IMF said. Tobias Adrian, director of the Monetary and Capital Markets Department at the IMF, told Bloomberg: “We worry that we could see a sell-off of sizable magnitude, given the level of stretched valuations.” Any such major market de-leveraging could trigger a cascading sell-off in other risk assets, including crypto. Again, possible, not definite, and investors would be mindful not to overlook the scenario.
4) Earnings season kicks off today, which investors will be looking to see evidence of the effects of price increases on corporate earnings. An underwhelming earnings season may be a forward indicator of slowing GDP growth, which many are already anticipating. Slowing economic growth, rising prices, undershooting employment growth is plenty for investors to get nervous about. On the contrary, if the earnings season proves these fears to be overblown, it could spur an equity rally. More likely, however, is the former. Corporates are about to give us evidence of trends we highly suspect have been present in the economy for many months now.
On the current balance of all influences, economists’ base scenario for the US dollar is a little more upside over the coming months and into next year, but no great rally. If so, the negative influence on crypto will probably be mild and not be enough to seize control of Bitcoin’s own cycle. However, we must remain vigilant of the catalysts which could change that scenario quickly. Risks to the sanguine base case are increasing.
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