UBS says peak is yet to come as Fed pivot unlikely

  • The surge in the US dollar waned this week as hopes grew for a Fed pivot away from giant rate hikes.
  • But the Fed is unlikely to start cutting rates, which means the greenback has room to rise, UBS said.
  • The war in Ukraine drags on, which will weigh on the euro and strengthen the dollar, according to its strategists.

Dollar strength should last a bit longer as a pivot from the Federal Reserve is likely to remain out of the picture, analysts at investment bank UBS said.

The US currency has appreciated rapidly this year against its major global counterparts, boosted to nearly 16% by Fed interest rate hikes and weakness in currencies such as the euro and the pound sterling.

But the U.S. dollar index retreated somewhat earlier this week as investors grew hopeful the central bank would back away from its aggressive monetary tightening. Those hopes were fueled by a drop in job vacancies in the United States and a lower-than-expected rate increase in Australia.

However, UBS analysts, led by CIO Mark Haefele, believe the Fed is likely to maintain its pace of giant rate hikes, which generally strengthens the dollar as higher yields attract overseas investors.

“We think it’s too early to talk about a peak in Fed aggressiveness or a top in the greenback,” they said in a note to clients on Wednesday.

“The number of job openings in the United States remains well above the number of unemployed, while the latest price index for basic personal consumption expenditures showed that inflation is still high.

“Fed officials, including Chairman Jerome Powell, have stressed that the central bank’s job is not yet done.”

Mary Daly, president of the San Francisco Fed, pointed out that the central bank was focused on cooling inflation by continuing to raise rates. But she said she would not ignore signs of strain in the economy, a concern for investors worried about a possible recession.

The U.S. dollar index, which measures the dollar against a basket of six currencies, climbed 0.36% to 111.49 early Thursday.

The impact of Russia’s ongoing war against Ukraine on European economies should support the dollar while weighing on the euro, according to UBS. The eurozone currency has fallen 12.4% in and out of parity against the dollar this year, and it was trading at $0.9898 when last checked on Thursday.

“Global uncertainty is expected to remain elevated as the war in Ukraine continues,” Haefele’s team said. “The dispute represents a particular headwind for the euro, which is the most important component of the DXY index.”

“We maintain a least preferred rating on the euro,” they added. “Against this backdrop, we continue to see general dollar strength through the end of the first quarter of next year.”

The UBS team said the U.S. jobs report for September, due out on Friday, should provide investors with a clue about the Fed’s future stance on monetary policy.

The market is looking for reasons for policymakers to look to cut rates, hike smaller amounts, or stick to its current hawkish approach.

The central bank has a dual mandate to keep both inflation and unemployment low, so a rise in unemployment would provide it with room to pivot to less aggressive rate hikes.

Investors will also be watching for the Consumer Price Index release next week, UBS analysts said. This will give the Fed an indication of the progress of its fight against inflation.

Read more: Decades-high inflation has sparked a ‘reverse currency war’ as soaring dollar forces central banks to scramble to catch up

Carol N. Valencia