FX Weekly Update – February 5th, 2024

Posted Under: Weekly updates

The dominant theme in currency markets in 2024 has been US economic strength, which is forcing markets to push back the timing of Federal Reserve rate cuts and is helping the dollar unwound most of the losses it suffered in late-2023.

Last week did not buck the trend. While the Fed January meeting did not move currency markets much, a blowout labour market report out of the US forced interest rate traders to push back the timing of the first cut from March till May. The fact that this economic strength is not matched elsewhere in the world is fueling the dollar rally, which rose last week against most major currencies, including all of those in the G10.

This week is exceptionally light in terms of both major data releases and monetary policy events in the main economic areas. The aftermath of last week’s Fed hawkishness, and evidence of an accelerating US economy, may keep most world currencies on the back foot against the US dollar, as we await the all-important inflation number from the various economic areas in mid-February. We maintain that these data points continue to be the key to medium-term currency movements.

GBP: The Bank of England’s Monetary Policy Committee edged slightly closer to a dovish stance last Thursday, as one member shifted from voting to a hike to a neutral stance, and another from neutrality to voting for a cut. However, the consensus position at the MPC is that while rates have reached their cycle high, there is little appetite for immediate cuts and the first cut will not come before the summer at the earliest. The growth forecasts were also revised upwards, with the bank saying that UK inflation would pick-up again after the second quarter.

Meanwhile, sterling continues to benefit from the highest short-term rates in the G10, as well as the modestly better economic data that we are seeing recently, at least compared to other European countries. Next week’s fourth quarter GDP data will be interesting in this regard, as there remains a very reasonable chance that we could see the confirmation of a technical recession.

EUR: Data last week confirmed that the economy of the Eurozone as a whole stalled both in the last quarter of 2023 and for the entire year, though it managed to avoid a technical recession. Inflation in January continued its downward trend, albeit the core number came in slightly above market expectations.

Overall, and absent an unexpected rebound in inflationary pressures, we think it is likely that the European Central Bank will cut rates ahead of the Bank of England and the Federal Reserve, though probably not till April. Swap markets are largely in agreement, with an April cut roughly two-thirds priced in. Focus this week will be on the latest PMI numbers (Monday), followed by December retail sales (Tuesday) and speeches from ECB members, including chief economist Lane, on Thursday.

JPY: The yen received some support last week following the release of the latest Bank of Japan meeting minutes, as policymakers continued to lay the groundwork for the start to rate hikes later in the year. One member noted that conditions for an end to the negative rate policy was already being met, while there were suggestions that the impact from the New Year’s Day earthquake would be limited. The minutes also noted that discussions were being had on the process for ending the current accommodative stance.

All signs suggest that us that a first rate hike as soon as the BoJ’s April meeting remains a very real possibility, with this now roughly 70% priced in by markets. But, the bank will need to be confident of an acceleration in wages before then. The annual ‘Shunto’ wage negotiations have commenced, and members may receive news on these salary negotiations in the next couple of weeks.

CAD: As tends to be the case, the Canadian dollar closely tracked its US counterpart last week, ending trading on Friday up on almost all of its major peers. Macroeconomic news out of Canada was largely encouraging last week, which likely helped CAD on its way upwards. While running on a lag, the November GDP report beat consensus, with the economy expanding by 0.2% on the month, which was double the consensus. The manufacturing PMI also picked up from the month previous, albeit remained in contraction at 48.3.

This week could be an important one, with PMI data to be followed by a speech from Bank of Canada governor Macklem on Tuesday. Friday’s labour report for January will also be closely watched. Following the near flat month of job creation in December, markets are eyeing a solid rebound in employment, and a modest increase in the unemployment rate. The latest wage number will also likely be key, given its implications for domestic inflation.

CNY: Despite pressure from the stronger US dollar and a sell-off in Chinese assets, the yuan ended the week only marginally weaker against the greenback. To some extent, this can probably be attributed to dollar selling by major state-owned banks, which were active in the market to support the currency on Wednesday, according to Reuters sources. The retreat from a weaker yuan is also evident in stronger PBOC fixings.

China’s Evergrande saga moved closer to the end last week with the Hong Kong court ruling on the liquidation of the company, which has become a symbol of the country’s real estate crisis. Markets are still waiting for any headlines that might offer hope of an upturn in the sector, but for now, it remains in a dire place. Recent developments on economic activity suggest that things have not changed much this year, with both the official and Caixin PMI indices remaining close to December levels. In summary, the manufacturing sector is still in or on the verge of contraction, while services activity, although in expansion, is not particularly impressive. Looking ahead, it will be worth keeping an eye on January’s inflation figures, which will be published on Thursday, expected to show a fourth month of falling consumer prices.