Written by Convera’s Market Insights Team
Regional equity divergence
Boris Kovacevic – Global Macro Strategist
The ongoing back-and-forth in FX markets continues as key US and European officials successfully pushed back against elevated policy easing expectations last week, driven by rebounding inflation rates and a strong US economy. Investors have recently come to terms with the fact that the G3 central banks are unlikely to starts their cutting cycles in Q1 already. However, the expected policy easing is still well above levels policy makers would be comfortable with as six rate cuts are currently being priced in for the European Central Bank and Federal Reserve for 2024.
Still, the repricing of yields higher and rate bets lower has benefited the US dollar, mainly via two channels. Firstly, via the lower probability of the Fed having to cut rates in March, and secondly via the risk sentiment channel. Because less policy easing from the Fed, ECB and BoE mean less appetite to take on risk. Which explains why the US dollar is up against every single G10 currency year-to-date. However, while European stock markets are down 4.8% from their peak reached almost exactly two years ago, US equity benchmarks climbed to another all-time record this week.
This regional equity divergence can be partially explained by the strength and resilience of the US household. Consumers continue to spend and retail sales have been rising both in nominal and real terms since 2021. Inflation adjusted US retail sales are up 16% since 2020, compared to having fallen 1%, 2% and 5% in Germany, France, and the UK. This weakness of the consumer is nothing new, but it makes European equities more dependent on monetary policy and when less policy easing is expected, European stocks underperform. This explains why the Stoxx 600, and FTSE 100 are down 1.2% and 3.1% respectively so far this year, while the S&P 500 has risen by 1.7%.
On the FX side, GBP/USD has been able to hold itself above the $1.27 level amid a lack of economic data. Today’s purchasing manager indices will decide the fate of the currency pair. The consensus does not expect much change, meaning that any bigger surprises could catch investors off guard.
EZ lending conditions to tighten further in Q1
Ruta Prieskienyte – FX Strategist
Traders keep a cautious stance ahead of the first European Central Bank (ECB) policy decision of the year as well as a slew of economic data from the US and Europe. Markets traded largely sideways for the majority of the session prior to disappointing consumer sentiment data, which jolted FX markets into action and extended euro selling action into the fourth week of January.
While largely non-market moving, the ECB’s latest Bank Lending Survey (BLS), released yesterday, showed that credit standards for loans to enterprises and households were tighter in Q4 of 2023, compared to Q3, and were expected to tighten further in the first quarter of 2024. In addition, the demand for loans continued to decline substantially, but less steeply than in Q3, driven by the multidecade high interest rates, lower financing needs for fixed investment by firms, subdued consumer confidence and weaker housing markets. Speaking of consumer confidence, the flash Consumer Confidence index (CCI) print for Eurozone fell in the month of January against market expectations of a fourth consecutive monthly improvement. The release sent a stark warning through the European markets that while leading indicators point to bottoming of the Eurozone economy, the progress remains slow and fragile. Subsequently, European stocks edged lower with the STOXX 50 and STOXX 600 both down around 0.3% d/d and euro fell against all G10 currencies. EUR/USD briefly depreciated to a 6-week low, before rebounding, and is currently trading 1.6% down YTD – worst start to the year since 2019. Meanwhile EUR/GBP also closed at a 20-week low around £0.8550.
Overall, EUR/USD is looking soft and prone to more weakness ahead of the ECB decision on Thursday. An improvement in flash PMIs released shortly today could give the euro another boost helping to reclaim ground above $1.09. Another discouraging flash print could see the pair testing 100-day SMA at $1.0771.
CAD remains steady ahead of BoC
Ruta Prieskienyte – FX Strategist
The Bank of Canada (BoC) is due to take the centre stage this Wednesday, one of the first G10 central banks to hold a rate decision this year. The central bank is widely expected to leave the target for the overnight rate at 5% when it meets this week amid signs of reinflation in the latest CPI print.
Since the last central bank policy rate meeting, we had Canada’s headline CPI rate accelerating to 3.4% y/y in December 2023 from 3.1% in the previous month. The uptick in consumer prices was attributed mainly to a rebound in gasoline costs due to dissipating base effects. Inflation also picked up for shelter as high mortgage rates continue to discourage home ownership and lifted rent prices instead. The result was consistent with the BoC’s signal that headline inflation is expected to remain stubbornly elevated, close to the 3.5% mark through the middle of this year.
The uptick in domestic CPI saw Canadian government benchmark bond yields rising across the curve. Specifically, the yield on the 10-year government bond jumped to a six-week high at 3.48% amid increasingly hawkish signals from BoC members. Policymakers continue to talk of their willingness to “raise the policy rate further if needed”, but we see little prospect of any additional policy tightening from here. The rates decision tomorrow will largely be a non-event, with BoC adopting a hawkish bias. We will be keeping a close eye for further communication on projected timeline of rate cuts, which we think is unlikely to happen earlier than Q2.
Meanwhile, markets are pricing in 50.2% probability of a rate cut in the April meeting, which is significantly down from around 80% around a week ago as investors are reconsidering the likelihood of a near-term BoC policy rate shift. This has supported the Canadian dollar for now, which is currently the best-performing major G-10 currency since Friday’s open, although its gains are minimal amid broad US dollar strength. Looking ahead, we think that the bullish USD/CAD momentum in place since 27th December is running out of steam and we expect the pair to depreciate from the current levels. Any hawkish BoC pushback tomorrow could be CAD supportive and help bring the USD/CAD pair back down towards the $1.34 handle.
Key global risk events
Calendar: January 22 – 26
Equities higher despite rising yields
Table: 7-day currency trends and trading ranges
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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.
