Dollar slips on Q3 data revisions, PCE inflation eyed

PCE prices for Q3 trimmed ahead of PCE inflation for November

The US dollar resumed its downtrend yesterday against all its major counterparts, with the aussie and the yen taking the most advantage and gaining more than 1% each. The greenback is trying to recover a small portion of yesterday’s losses today.

What may have encouraged traders to sell the dollar is the downside revision in the q/q rate of core PCE prices for Q3, which was released alongside the final estimate of GDP for the quarter. The PCE rate was revised down to 2% from a prior estimate of 2.3%, signifying a huge drop from 3.7% in Q2. What’s more, consumer spending was trimmed to 3.1% from 3.6%, and the overall GDP rate was brought back to 4.9% from 5.2%.

Today, the spotlight is likely to fall on the year-on-year rate of the core PCE index, the Fed’s favorite inflation gauge, for November. Expectations are for a small slowdown to 3.4% y/y from 3.5%, but with the quarterly rate of Q3 being revised down, a lower y/y print for last month cannot be ruled out.

Following yesterday’s data, investors have added to their Fed rate cut bets, now penciling in 155bps worth of reductions next year, and pricing in around a 95% chance for the first quarter-point cut to be delivered in March. With that in mind, a larger than expected slowdown in today’s inflation data could convince participants that a March cut is a done deal and may deepen the dollar’s wounds.

Aussie and yen remain attractive

With the RBA seen cutting its overnight cash rate by only 50bps next year, and Fed rate cut expectations not only hurting the dollar but boosting the broader risk appetite as well, the aussie was yesterday’s main gainer, with the yen securing second place on bets that the BoJ will eventually decide to take interest rates out of negative territory at some point in the coming months.

Today, during the Asian session, both of Japan’s national CPI rates slowed, but remained above the BoJ’s 2% objective, allowing investors to assign a 30% probability for a small 10bps hike in January. That said, April seems a better choice for ending the negative interest rate regime. Given that they pay close attention to wage growth, officials may prefer to wait for the outcome of next year’s spring negotiations, with unions pushing for another strong pay hike. Indeed, the market also sees an April hike as more likely, giving an 80% chance for such an action.

Wall Street and gold cheer increasing Fed cut bets

The increasing speculation about massive rate reductions by the Fed helped Wall Street rebound yesterday, with the S&P 500 and the Nasdaq gaining more than 1%. Although another slide cannot be ruled out due to hedging activity for the Christmas and New Year holidays, the broader outlook remains positive for now.

Expectations of aggressive rate cuts by the Fed are helping present values of high growth firms that are usually valued by discounting expected cash flows for the quarters and years ahead, while the continued rally despite overly stretched valuation multiples suggests that market participants are still calculating high present values of future growth opportunities. Having said that though, this also increases the risk of an abrupt sell-off in case data point to a worse-than-anticipated economic outlook or in case the Fed does not proceed with as aggressive cuts as the market currently anticipates.

Gold also took advantage of the dollar’s slide yesterday, although Treasury yields held relatively steady, with the 10-year rate even rising somewhat. The advance is continuing today, with the precious metal breaking above last Thursday’s high of $2,048. As Fed rate cut bets keep reducing the opportunity cost of holding bullion, a clear close above that zone today could allow post-Christmas advances towards the $2,080 zone, marked by the high of May 4.