Overstretched US dollar sets the stage for a financial correction in December

By Newsdesk

December 01 2023
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As the US bond market sees a robust rally, the financial landscape braces for an impending correction. Ipek Ozkardeskaya, Senior Analyst at Swissquote Bank, sheds light on the current economic scenario where the tide appears to be turning, with implications that are far-reaching across global markets.

Overstretched US dollar sets the stage for a financial correction in December

In a remarkable shift, comments from hawkish Federal Reserve members hint at a positive outlook on policy positioning to curb inflation, with Christopher Waller expressing increasing confidence in the policy's ability to "slow the economy and get inflation back to 2%." The repercussions of such dovish stances have been immediate, pushing the US 2-year yield beneath the critical support of 4.80% and the 10-year yield below 4.30%. This has, in turn, contributed to a tumbling dollar index, which has fallen to its lowest levels since August, and a surging gold price, catapulted past the $2050 mark.

The weakening US dollar has rippled through currency exchanges worldwide, lifting the EURUSD above the 1.10 psychological level, the Cable to 1.27, and nudging the USDJPY just under the 147 mark. These movements stand against a backdrop of "a significant meltdown in the US yields – which are the most popular indication of the safe rate on which investors could build their risk/return models," Ozkardeskaya explains. Investors now seem primed to accept lower returns or higher risks in alternative ventures as yields diminish.

This strategy has reverberated through the markets, evidenced by soaring option volumes in companies like Gamestop and a general retail trading frenzy, signaling market optimism that Ozkardeskaya believes indicates an "overstretched" rally. With asset classes across the board showing overbought or oversold signals, the market seems primed for a correction, with the RSI indicators sounding the alarm.

Underlying these trends is the contention that only a US economic downturn, hinting at a "hard landing," could vindicate the market's current prediction of a 100bp rate cut by the Fed next year. Meanwhile, central bankers globally, including those from the European Central Bank and the Reserve Bank of Australia, uphold a guarded stance, underscoring potential inflationary bumps and the enduring nature of inflationary pressures.

At this junction, Ozkardeskaya foresees a potential correction for the overextended selloff of the US dollar, especially as December approaches. Critical economic data expected today, such as the US GDP update and European inflation figures, are likely to further influence market directions. A strong US GDP growth report would bode well for the USD, whereas softening inflation may put pressure on the euro.

Capsulating developments in the energy sector, US crude oil prices have tepidly recovered, amidst OPEC's scheduling struggles which hint at further price volatility ahead. Ozkardeskaya concludes, positioning observers to anticipate how these dynamic economic indicators will shape financial markets in the closing month of the year.

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