Written by Convera’s Market Insights Team
Dollar stuck in the middle
Boris Kovacevic – Global Macro Strategist
The US dollar has lost some momentum this week, after recording its best yearly start since 2011. It seems that the Greenback is finding it hard to push higher against the backdrop of rising equity markets and stagnating government bond yields. Overall, trading actions remained muted as investors wait on the important US CPI report due later today. The US Securities and Exchange Commission meanwhile cleared the way for the first Bitcoin ETF, which will allow the public to trade the largest cryptocurrency as easily as stocks and bonds. The message had been the main headline from a day that lacked any tier 1 data releases. US equity markets surged once again and are closing in on their all-time highs reached at the end of December.
Today should see price action pick up with the release of the ECB economic bulletin, US inflation and initial jobless claims. The monthly report from the Bureau of Economic Analysis (BEA) could show a soft inflation reading due to the continued fall in goods prices. This should be seen as progress by the Federal Reserve and could strengthen the case for a March rate cut. Economists see the core inflation rate fall to 3.9%, which would be the first sub-4% print since early 2021. Going into the meeting, markets are pricing in policy easing worth 150 basis points from the Fed for 2024.
The US Dollar Index has been in a clear downward since November and has shed 4.7% of its value over the course of the past 12 weeks. However, looking at the post-pandemic trading range of the Greenback between the 2021 low of 89.00 and 2022 high of 114.00, the current spot rate of 102 places us comfortably in the middle of that range. Looking for new catalysts for another breakout, we mention three risks to be aware of. (1) Inflation starting to trend higher again, (2) US growth underperforming expectations or (3) geopolitical tensions flaring up. Going forward, we continue to see a slowdown in the labor market and with excess savings having mostly been depleted, we expect US growth to fall to below 1% this year. We also expect political uncertainty to pick up materially, given that uncertainty tends to rise in the months ahead of an US presidential election, peaking in the month of November.
ECB warns Europe’s headed for another downturn
Ruta Prieskienyte – FX Strategist
The euro marginally gained against the US dollar as investors digested comments from multiple ECB’s hawks while eagerly awaiting a crucial US CPI print that could shed light on when the Federal Reserve might initiate interest rate cuts this year.
The vice president of the European Central Bank (ECB) Luis de Guindos issued a gloomy warning for the markets that the eurozone economy looks set for another downturn in Q4 2023 while a recent pick up in inflation could persist in the upcoming months. Soft indicators pointed to an economic contraction in December and risks to near term future growth are tilted to the downside. The eurozone economy stagnated for much of 2023 and contracted by 0.1% in Q3. Only a mild pick up in activity is expected this year with World Bank forecasting 0.7% growth for 2024, up from 0.4% in 2023. The ECB is facing a tough dilemma during the January meeting in two weeks’ time over how early to start cutting rates when the economic outlook is fragile, and inflation remains above its 2% target. In parallel, Isabel Schnabel reinforced the message that the central bank remains data dependent and further evidence is needed before rate cuts can be discussed. Subsequently, markets downgraded their policy easing expectations are no longer pricing in a rate cut in the first quarter of 2024.
A lack of sustained bullish momentum saw EUR/USD wavering in a tight range of €1.0921 – €1.0981 ahead of this week’s key risk event. A downside surprise to US CPI could see investors raise Fed cut expectations. EUR/USD could then potentially rally above the €1.1000 level and towards the December highs of €1.1100s.
UK inflation to fall back to 2%
Boris Kovacevic – Global Macro Strategist
The British pound is slowly but surely making its way to the upper $1.27 levels as a lack of data has allowed the positive effects of last weeks data surprise from the UK to linger around for a bit. GBP/USD is on track to record its seventh weekly appreciation out of the last nine and has risen around 4.3% over the course of this period. The pound has pushed higher against all but one currency pair within the Group-of-Ten this week. With inflation still well above the G7 average and the British economy outperforming expectations, investors have been comfortable pushing the currency pair to $1.2770.
However, we do not think that the UK is in a fundamentally different position than the US or Eurozone and see inflation falling back to the 2% target of the Bank of England around the middle of the year. We see a high probability of the BoE having to revise down its inflation forecast at the monetary policy meeting in February. This assumption is both driven by the fall of energy prices over the past few weeks and falling inflation expectations from key UK surveys. This will have implications for how investors will price the BoE’s policy path for 2024.
Still, that doesn’t necessarily mean that the pound will come under pressure from falling inflation, as long as global equity markets are rising due to the expectations of significant Fed rate cuts. The dollar dynamic is currently responsible for driving GBP/USD price action. And while slower inflation and sooner BoE rate cuts would put downside pressure on the pound, the US side of the equation will decide the short-term fate of the currency pair. However, UK macro will most likely not be GBP positive over the next months.
GBP touching weekly highs across the board
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: January 08 – 12
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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.
