Synopsis:

TD Securities discusses the emerging signs of a regime change in the FX markets, focusing on the transition from a bear flattening regime to the complexities of steepeners, and the implications for the USD and emerging market currencies.

Key Points:

• End of Bear Flattening Regime: The bear flattening regime, characterized by shorter-term interest rates rising faster than longer-term rates, appears to be over.
• Debate Over Steepeners: The market is trying to understand the new regime, whether it's a bull or bear steepener. A bull steepener occurs when long-term rates rise faster than short-term rates, often indicating expectations of stronger economic growth or inflation. Conversely, a bear steepener can indicate rising long-term rates due to inflation concerns or policy tightening.
• Impact on the USD: Bull steepeners, which TD Securities deems bearish for the USD, could lead to significant losses for the currency. Historically, this regime has produced the most significant declines in the USD when compared to other yield curve regimes.
• Beneficiaries of the Change: High-quality emerging market currencies (EMFX) are likely to benefit the most from this transition.
• Leading Indicators and Market Repricing: Changes in leading indicators, such as data surprises and growth expectations, have recently moved against the USD.
• Fed's "Language" Pivot and Inflation Data: Last week's lower-than-expected inflation data supports the Federal Reserve's recent shift in language, emphasizing the impact of the summer's sharp tightening of financial conditions.
• USD's Positioning Signal: The Market Reversal Sentiment Indicator (MRSI) for the USD is showing signs of weakening, indicating that the USD's long position is easing across portfolios.

Conclusion:

TD Securities' analysis suggests a notable shift in the FX market regime, moving away from the bear flattening phase and grappling with the implications of steepeners. This change is anticipated to be unfavorable for the USD, particularly in the scenario of a bull steepener, and favorable for high-quality EMFX. The market's response to recent data and the Federal Reserve's policy adjustments is also contributing to a reevaluation of the USD's strength, with potential implications for global currency dynamics.