FX Monthly Outlook: US Dollar stalls from rally

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The US dollar retreated from all-time highs in October as the Fed cut interest rates for the third time this year. An agreement to extend the Brexit decision and some daylight in Chinese/American trade discussions have lessened risk perception among investors. A stalwart safe-haven currency, the USD remains a refuge for investors as major headwinds ease, with strong US equity markets and economic fundamentals continuing to drive its favorability over peers.

What happened?

Risk of a no-deal Brexit faded: Fears the UK would crash out of the EU without a deal lessened with the passing of a formal withdrawal agreement led by Boris Johnson. The agreement is an unratified treaty between the EU and the UK setting the terms of the withdrawal. The pound soared from 1.22 to 1.30 with news of a diminished likelihood of a no-deal Brexit.

Brazil passed pension reforms: With an aim to reducing sizeable (and increasing) deficits of private and public pensions, Brazilian lawmakers approved a bill which overhauls the country's pension system. The bill established minimum retirement ages and contribution periods. Markets welcomed the bill and the real gained 5% from historical lows.

Brazil botched oil auction: Brazil’s largest-ever auction of oil deposits failed to garner a single bid from major foreign oil companies. The lack of participation from companies including Exxon Mobil left Brazilian oil giant Petrobas in control and highlighted the continued reluctance of foreign direct investment in the country. As a result, the real fell 4%—reversing gains recently made following pension reforms.

Argentina imposed wider currency controls: Alberto Fernandez defeated incumbent Mauricio Macri in Argentina's October presidential elections. Fernandez supports capital controls and increased restrictions of local USD purchases to just $200 per month (down from $10,000 a month ago). The expanded currency controls revisit prior era "blue market" underground exchange rates. The rate-to-buy 1-year Argentina Non-Deliverable forwards are trading at a 60% discount vs spot.



What's in play?

US/China 'phase 1' trade negotiations begin: Markets saw reason for optimism following the announcement of an agreement between China and the US to a three-phase negotiation approach. Both China and the US have agreed to remove certain tariffs should a phase 1 deal be reached. US equity markets and the Chinese RMB responded positively to the news with the RMB trading below 7/USD for the first time since August.

Mexican peso up—for now: The peso has rallied almost 6% since August as Fed rate cuts have made the MXN carry trade more attractive. However, as Congress prepares a budget for next year, debates on spending bills that include funding a border wall could put the peso's rally at risk (since a renewed commitment to the border wall could portend further tax implications). Further, the IMF lowered its growth forecast for Mexico. The Bank of Mexico may make additional cuts to rates during its November 14 and December 19 meetings.

Chilean peso hits record low: Triggered by a subway toll increase and fueled by on-going frustration with the country’s inequality, large-scale protests in Santiago led to a sell-off of the peso. President Sebastian Pinera’s commitment to overhaul the constitution threatens to reduce protection of private ownership and market principles and led to the sell-off (to all-time lows) reflecting the market’s concern regarding the changes. 

What's next?

US Fed to carefully watch data: Despite historically low unemployment and under-target inflation rates, the Fed proceeded with a highly-anticipated rate cut in October reducing the target rate 25bps for the third time in 2019. Economic data releases will set the stage for 2020 monetary policy, but further cuts for 2019 are not anticipated.

UK general election: On December 12, UK voters return to the polls for a general election. The third since 2015, the vote can be viewed as a proxy for the determination of EU membership. A strong performance by Jeremy Corbyn's Labor party could potentially rescind Brexit entirely. In that event, and should political and trade certainty return to the UK, sterling values below 1.25 would be less likely to persist, with the currency potentially revisiting 1.35 GBP/USD.

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About the Author

William Joyce is a Vice President in Foreign Exchange Sales with Silicon Valley Bank based in Austin, TX. Will works with clients to manage the opportunities and risks associated with doing business internationally as they relate to FX markets.

Prior to SVB, Will worked for Bloomberg L.P. in San Francisco where he helped institutional investors and banks use data and analytics to better act on market information. He started his career with Fidelity Investments in Boston, MA and is a graduate of the College of Charleston with a B.S. in Economics.