Written by the Market Insights Team
Bracing for retail sales after inflation dip
Boris Kovacevic – Global Macro Strategist
Financial markets are highly sensitive to inflation concerns, and even a slight data miss yesterday has been interpreted as bullish for equities and bonds. The US dollar declined for a third consecutive day as investors responded positively to the second weaker-than-expected inflation report this week (core CPI and core PPI).
After weeks of upward pressure on the Greenback, this report has given investors a chance to lock in profits. The upward trend that started in October of last year remains intact as long as DXY remains above 108.60. Meanwhile, the US 10-year Treasury yield is set to post its second-largest daily drop of the year.
Still, our chart below highlights that broad inflation measures are still trending upward as reflationary pressures resurface. While the continued decline in core, shelter, and services inflation is encouraging, sustained progress is necessary. A repeat of yesterday’s figures from January through March would provide greater confidence that the Federal Reserve remains on the right track.
There’s little time to dwell on the data as investors prepare for today’s upcoming releases. Scheduled reports include retail sales, initial jobless claims, the Philly Fed Manufacturing Index, and the NAHB Housing Index. Consumers likely began frontloading purchases ahead of the Trump administration’s anticipated tariff hikes, likely emptying their wallets in December. Retail sales are expected to reflect robust holiday shopping and stronger car sales. These factors should help limit downward pressure on the market through the remainder of the week.
Pound’s recovery short-lived
George Vessey – FX Strategist
Sterling has risen for three days straight against the US dollar, albeit unconvincingly. GBP/USD bounced off a floor around the $1.21 mark and extended towards $1.23 on Wednesday on the back of softer UK and US inflation reports. Such GBP strengthening in the wake of cooling domestic inflation data is further evidence that a fiscal risk premium has been embedded into UK asset markets over the past couple of weeks, rather than the short-term gilt moves purely just following the wider trend.
The softer core US inflation figures added fuel to sterling’s recovery, but GBP/USD reversed back towards $1.22 before the day was up and has opened on the backfoot this morning after weaker-than-expected GDP data. The UK’s economy grew 0.1% in November on a monthly basis, slightly lower than the forecasted 0.2%. The three-month GDP figure was flat, in line with estimates. Meanwhile, industrial production in November was lower than expected. It’s clear the UK’s cyclical backdrop has turned for the worse and the future is dim amidst expected government spending cuts. It’s hard to ignore the rise in gilt yields over the past couple of weeks and we think this will force a round of spending cuts from the government when it announces a review on 26 March. These expected cuts coinciding with the turn lower in UK service price inflation might finally allow the Bank of England (BoE) to reduce interest rates more aggressively too. The market prices just over 50bp of BoE rate cuts this year – i.e. two quarter-point cuts – though we think this should be more like three of four.
This could weigh on the pound as we expect its correlation with short-dated yields to reconnect. Moreover, positive GBP positioning could be its downfall going forward. Sterling’s depreciation against the USD is more a reflection of broad-based dollar strength than sterling weakness. The trade-weighted GBP index has weakened from recent highs but remains above the average level since the mid-2016 Brexit vote – and well above the Truss-era record lows back in 2022. Consistent with that, the recent depreciation in sterling’s trade-weighted index is not unusually large compared to other major markets. meaning the pound’s recent decline may have further to run across the board.
Euro fails to capitalize on softer us data
Boris Kovacevic – Global Macro Strategist
The euro was set for a third consecutive day of gains against the dollar, supported by weaker-than-expected US data. However, during the US session, bearish sentiment prevailed, dragging EUR/USD down from $1.0350 to below the $1.03 mark once again. Unlike the pound, yen, or yuan, which have shown some ability to capitalize on softer US data, the euro continues to struggle. The common currency remains heavily influenced by external developments due to Europe’s weak economic growth outlook.
Eurozone inflation edged higher in December but failed to alter the European Central Bank’s (ECB) current policy stance. This was echoed in comments from ECB Chief Economist Philip Lane and Vice President Luis de Guindos, who reiterated the likelihood and necessity of further rate cuts. With the deposit rate at 3% and the neutral rate estimated around 2–2.5%, policymakers have ample room to reduce rates further.
The macroeconomic picture offers little hope for a turnaround. While Eurozone industrial production grew for a second straight month with a modest 0.2% expansion in November, this growth is insufficient to reverse the region’s economic malaise. Germany remains a key drag on the Eurozone narrative. The German economy contracted for the second consecutive year in 2024, marking its first back-to-back decline since 2003. Unfortunately, the 2025 outlook appears equally grim, compounding concerns about Europe’s economic prospects.
JPY top of FX pack over the week
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.