The US Dollar (USD) fell as risk sentiment stabilized and soft ADP data reinforced expectations of a Fed rate cut next week. Despite potential short-term stabilization, the dollar faces continued downside pressure from overvaluation and seasonal trends, ING's FX analyst Francesco Pesole notes.

Dollar overvaluation adds to downside risks

"The drivers of yesterday’s USD drop are to be found in the stabilization of risk sentiment, some soft US data and the fact that the dollar’s starting position this week was one of marked short-term overvaluation versus most of the G10. All this against a backdrop of the negative USD seasonality in December."

"After yesterday’s 32k drop in ADP payrolls, a Fed cut next week looks even closer to a certainty. The OIS curve is pricing in 25bp, meaning the Fed would face a potentially sharp adverse reaction in risk assets should it decide to hold. At the same time, there is only another 15bp priced in by March, meaning that expectations are firmly on a hawkish cut in December. Our view remains that data will justify two more cuts early next year, which underpins our view that the dollar won’t make a comeback even in the seasonally favorable first quarter."

"Today, expect some focus on Challenger’s job cuts and jobless claims. However, the big release of the week was yesterday’s ADP payrolls, and unless PCE inflation spikes tomorrow (PPI and CPI for September suggest not), markets are unlikely to materially review their Fed pricing before next Wednesday. This means we could see some stabilization in the dollar today, even though adverse seasonality and some lingering overvaluation against most G10 peers mean the risks remain predominantly on the downside."