Written by Convera’s Market Insights team
Dollar retraces as expected
George Vessey – Lead FX Strategist
We noted we could see some modest profit taking on the US dollar given its recent rally, and indeed yesterday saw the dollar index retrace lower after its 1.4% rise over Friday and Monday. Asian equities advanced higher, tracking gains on Wall Street overnight, whilst riskier currencies clawed back some of their recent losses against the world’s reserve currency. The USD remains close to its highest level in almost three months though, buoyed by strong economic data and hawkish Federal Reserve speak.
Money markets are now only pricing a 15% chance of a Fed rate cut in March compared with a 40% chance last week following a huge upside surprise in the latest US non-farm payrolls and the biggest rise in services sector activity in four months. Consequently, soft landing and recession worries in the US continue to abate, and instead we’re seeing more market participants calling for a no landing or even a re-acceleration in the US this year. Such a scenario will further call into question both the timing and amount of policy easing by the Fed. As we’ve witnessed via the hawkish repricing in Fed rate expectations over the past week, less Fed easing is likely to favour a stronger US dollar.
After yesterday’s decent demand for 3-year US government bonds helped to drive US yields slightly lower, as well as the dollar, the focus shifts to the 10-year and 30-year auctions today and tomorrow respectively. Data is mostly second tier in nature for the rest of the week, so is unlikely to drive market volatility.
Pound rebounds but still at risk
George Vessey – Lead FX Strategist
The pound has had a tough start to February, appreciating against less than 40% of its global peers so far, compared to over 70% in January. We did see a modest rebound in sterling demand on Tuesday though, allowing GBP/EUR to reclaim €1.17 and GBP/USD $1.26.
Not much has changed in terms of rate differentials. The Bank of England (BoE) is still not expected to cut interest rates as much as the ECB or Fed this year, but we have seen a widening divergence in economic surprises, which measures the gap between consensus expectations and realised data. The UK has seen a greater number of weaker economic surprises compared to that of the US and Eurozone over the past month, which may explain some of sterling’s recent weakness. Stagflation fears are also more elevated in the UK due to services inflation proving stickier, or least lagging the falls seen in the US and Eurozone. That said, one could argue that this supports the notion of higher BoE rates for longer, providing the pound a yield advantage as we saw in January. However, the BoE’s most dovish interest-rate setter, who voted for a rate cut last week, said yesterday that demand in the UK economy is so weak now that there’s a risk of a big shock from maintaining restrictive interest rates. The latest UK inflation report will be published next week and if it resumes its descent after December’s surprise uptick, this could lead to a dovish repricing in UK rates and weigh further on the pound.
The UK’s data docket is quite thin this week, but we did have retail sales from the British Retail Consortium yesterday showing a 1.4% rise on a like-for-like basis in January 2024 from a year ago, slowing for the second straight month.
Mixed euro action on mixed European data
Ruta Prieskienyte – FX Strategist
The euro continued to trade in a tight pattern against the US dollar on Tuesday as investors await further indications of when central banks will begin making rate cuts with broader markets hinging their focus on interest rate activity. Europe’s STOXX 50 continued to hover at 23-year highs and German 10-year bond yield stabilized around 2.3% in the aftermath of the largest two-day sell-off in almost a year. European economic data came in mixed, exposing a weakened domestic European economy.
On the one hand, survey data from the ECB revealed that Eurozone consumers reduced their expectations for inflation over the next 12 months in December to 3.2%, marking the lowest level since February 2022. German factory orders also surged by 8.9% m/m in December, the most in over three years, driven by “an exceptionally” high number of aircraft orders. Conversely, retail sales in the bloc fell the most in a year, dropping by 1.1% m/m in December 2023, as persistent high inflation and elevated borrowing costs continued to weigh on demand. To add to the pain, construction output contracted the most since the aftermath of the COVID-19 outbreak and business confidence remained weak in January, with firms generally expecting a further decline in activity over the coming year.
EUR/USD continued to trade around the $1.0750 level, the lowest point since mid November, and momentum remains limited with the US dollar seeing a soft pullback heading into the midweek. EUR/CAD touched a fresh 16-week low as Canada’s Ivey PMI surprised to the upside. Investors anticipate that the ECB will take its time before considering monetary policy relaxation, despite the release of weak economic data, which should support the common currency. Projections point to approximately 125 basis points of interest rate cuts from the central bank by year-end, down from the 160 basis points priced in at the end of January.
GBP/USD swings over 2% in last seven days
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: February 05-09
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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.
