US financial conditions have eased incredibly in recent weeks, unwinding essentially all of the FCI tightening since the middle of the year. While this is perhaps unsurprising given the Fed's stated plans to slow the rate hikes, it is also likely unsustainable. Of course, the ultimate destination of the policy rate should matter more than the pace of hikes; setting a slower course tends to ease financial conditions by lowering rate vol and skewing the market to respond more to downside surprises while looking through upside surprises.
Indeed this is especially important in the current context of still fairly robust economic data, including Friday's employment report, which will lead some to assume that negative impulses on growth from initial tightening are primarily behind us while factoring in a possible earlier China reopening, which could both add to inflationary pressures. Although I always caution against reading too much into one particular payroll report.
The Committee has communicated that it intends to slow the pace of hikes imminently. Unlike at Jackson Hole this summer, Chair Powell did not express any apparent unease with recent market moves. In my view, this makes it hard for the Dollar to regain ground soon. This dynamic could extend further if the Committee signals to slow the pace again in February, as the market now expects. But, ultimately, I think the recent market moves could prove self-defeating—especially if the FCI impulse to 2023 growth turns more favourable. Therefore, the Dollar could get a second wind, so it is too early for a sustained turn.
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