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CAPITALDIGEST MARKET REVIEW, 14/11/2022

EURO, STERLING BOUNCE, DOLLAR DROPS AS INVESTORS CASH IN Euro and sterling rose against the safe-haven dollar on Monday, supported by a risk-on sentiment across markets as investors digested positive euro zone data and looked to cash in on the strength of the U.S. currency. A survey showed on Monday that investor morale in the euro zone improved in November, the first time it rose in three months, reflecting hopes that recent warmer temperatures and falling energy prices will prevent gas rationing on the continent this winter. The euro was up 0.69% to $1.0029, its highest level since Oct. 27, while sterling was last trading at $1.1534, up 1.40% on the day. Investors were also cheered by a readout on Monday showing that German industrial production grew in September, beating analyst expectations. Industrial output was up 0.6% on the previous month, the Federal Statistical Office said. Against a basket of currencies, the dollar index fell 0.91% to 110.070. Though it had lost almost 2% at the end of last week after reports that China would make substantial changes to its COVID-19 policy in coming months, the downward move in the dollar on Monday was likely more about positioning, said Bipan Rai, North America head of FX Strategy at CIBC Capital Markets. “I think the market’s got really long US dollars, and is now just taking profits here. That’s behind the move for today,” he said. Investors were also assessing Friday’s U.S. jobs report which showed that firms added a more-than-expected 261,000 jobs in October and hourly wages continued to rise, evidence of a still-tight labour market. But hints of some easing of market conditions, with the unemployment rate rising to 3.7%, fuelled hopes that the much sought-after Federal Reserve pivot could be on the horizon, capping potential gains for the dollar. DOLLAR HIGHER AS INVESTORS LOOK PAST U.S. MIDTERMS TO INFLATION DATA The dollar advanced against most major currencies on Wednesday, as results so far for the U.S. midterm elections showed little evidence of a “red wave” resounding Republican victory that some expected, leaving investors to focus on upcoming inflation data. Republicans made modest gains in the midterms but Democrats performed better than expected, as control of the Senate hinged on three races that remained too close to call. A stronger showing by Republicans may have backed the idea of less fiscal support and potentially a lower peak in the Fed’s terminal rate, which would have been dollar negative, said Joe Manimbo, senior market analyst at Convera in Washington. “Markets are now in the process of turning the page on politics and bracing for the inflation report tomorrow,” Manimbo said. Investors are waiting to see whether Thursday’s U.S. Consumer Price Index data will spur the Federal Reserve to continue to increase interest rates well into next year in a bid to curtail inflation, or whether they might be able to ease policy tightening. The dollar has retreated from multi-decade highs in recent weeks as investors take profits following a months-long rally and as speculation grows that the Fed may be inching closer to pulling the curtain on its dollar-supporting interest rate hikes. “The inflation report could be a good litmus test to gauge whether dollar sentiment has materially softened,” Manimbo said. The euro was 0.7% lower against the dollar at $1, while the greenback was up 0.7% against the yen. DOLLAR SLUMPS AFTER CPI DATA SUGGESTS FED MAY EASE RATE HIKES The dollar fell sharply on Thursday after U.S. consumer prices rose less than expected last month and data pointed to underlying inflation having peaked, opening the way for the Federal Reserve to slow its aggressive interest rate hikes. The consumer price index rose 0.4% in October, the same increase in the prior month, the Labor Department said. Economists polled by Reuters had forecast the CPI would advance 0.6%. Excluding volatile food and energy, core CPI increased 0.3% month-over-month after gaining 0.6% in September. “A softer than expected inflation report is acting as a tailwind for markets. Every line of the report shows sequential improvement,” said Art Hogan, chief market strategist at B. Riley Wealth in New York. The good news is that we saw a significant sequential improvement, inflation is clearly moving in the right direction. And that keeps a more hawkish Fed at bay.” The dollar index fell 1.495% and fed funds futures priced in a sharp decline in expectations for the Fed’s peak target rate, which fell below 5%. The likelihood of a 50% basis point hike by the Fed instead of 75 in December rose to 71.5%. Annual inflation slowed as big increases last year drop out of the calculation for the index. CPI rose 7.7% in October on an annual basis, down from 8.2% the prior month, as headline inflation fell below 8% for the first time since February. The CPI report has reinforced the sell-off momentum in the dollar,” said MUFG currency strategist Lee Hardman. “It gives the market more confidence that there could be a turn in the inflation cycle and the Fed could slow the rate hike pace in December.” OVERSOLD STERLING SURGES AGAINST EURO, INCHES UP VS DOLLAR Sterling surged against a weakening euro and also inched higher against a strengthening dollar ahead of U.S. CPI inflation data, bouncing back from a sharp slide. After falling 1.6% on Wednesday, the pound rose 0.13% to $1.1375. Against the euro, sterling jumped 0.9% to 87.43 pence, reversing the 1% fall on Wednesday and setting the UK currency on track for its biggest daily gains against the single currency in one month. “Sterling may have become a little oversold yesterday, which against a modestly constructive risk backdrop ahead of CPI has encouraged a modest sterling bounce,” Jeremy Stretch, head of G10 FX strategy at CIBC, said. “However, we would prefer to remain a seller of sterling rallies,” he added, mentioning expectations for weak GDP figures on Friday and data showing UK house prices fell in October amid rising mortgage rates. The outlook for the UK economy is gloomy, with the Bank of England warning last week of the risk of a two-year recession in Britain. Investors are now waiting for Prime Minister Rishi Sunak and his finance minister Jeremy Hunt to announce their first budget programme on Nov. 17. The new government is likely preparing to announce major tax increases and spending cuts. Sterling fell to a record low against the U.S. dollar in the wake of former PM’s mini-budget in September and the Bank of England had to step in and buy government bonds to halt a firesale of assets by British pension funds. DOLLAR FLAGS AFTER BIGGEST DAILY FALL SINCE 2015 The dollar fell on Friday, extending losses from the previous day, when it posted its largest one-day drop in seven years after U.S. infData on Thursday showed consumer inflation rose 7.7% year-on-year in October, its slowest rate since January and below forecasts for 8%. The dollar staged its biggest drop since late 2015 as Treasury yields plunged, while other currencies – the yen and the pound in particular – jumped. lation came in lower than expected, making it less likely the Federal Reserve will keep aggressively raising rates. Investor risk appetite got an additional boost from Chinese health authorities easing some of the country’s strict COVID-19 restrictions, including shortening quarantine times for close contacts of cases and inbound travellers. The dollar index was down nearly 0.5%, while risk assets including stocks, emerging-market currencies and commodities rallied. But slowing inflation, while positive for borrowers, reflects a slowing economic backdrop, analysts said. “It can be a little dangerous in that the ‘bad news’ is still out there and could come back to burn us, particularly with respect to the Fed,” Rabobank currency strategist Jane Foley said. The dollar has risen by 12% this year against a basket of major currencies, in light of the Fed’s determination to bring inflation, which almost hit double digits earlier this year, back towards its target of 2%. Other central banks have followed suit, with the exception of the Bank of Japan, and, as a result, the yen has witnessed its largest decline against the dollar since 1979. The dollar, which has gained 22% in value against the yen this year, its steepest gain since 1979’s 24% rise, was last down 0.3% against the Japanese currency at 140.60 yen.