Synopsis:

MUFG raises the question of whether the recent reduction in US yields might trigger a more hawkish stance from the Federal Reserve, in light of the lessening pressure on the central bank to increase rates due to the stronger-than-expected economic growth in the third quarter.

Key Insights:

• Yield Retracement: There's recognition that the 10-year US Treasury yield has dropped significantly from its peak but still remains above the levels seen earlier in the year, suggesting that financial conditions are tighter than before.

• Fed's Response to Financial Conditions: While financial conditions have eased somewhat, they still maintain a degree of tightness that might require the Fed to continue its rate-hiking path to manage inflation and economic growth.

• Market Anticipation of Fed Communication: Investors are awaiting potential signals from Fed officials, including Chair Powell, regarding their plans for the December meeting.

• Potential for Hawkish Signals: MUFG speculates that unless the Fed provides unexpectedly hawkish indications, market participants are likely to maintain the belief that major central banks, including the Fed, have concluded their rate hikes.

• Impact on FX Volatility: The perceived end of the rate hike cycle by major central banks is suggested to contribute to lower volatility in the foreign exchange markets.

Conclusion:

MUFG posits that unless the Federal Reserve conveys a stronger intention to continue raising rates in its upcoming communications, the prevailing sentiment that the cycle of rate hikes has concluded will persist. This belief underpins the current lower volatility in FX markets. Investors and traders will pay close attention to upcoming remarks from Fed officials for any indication that could challenge this view.