FX Weekly Update – January 8th, 2024

Posted Under: Weekly updates

The furious bond rally in the last few weeks in 2023 has stopped in its tracks and reversed, as markets pare back expectations of Federal Reserve interest rate cuts in 2024. Markets dutifully followed the leads from interest rates: risk assets and commodity fell, and the dollar rose against every major currency with the notable exception of the Mexican peso, which built on its stellar 2023 performance to end up higher against every other major currency. Attention this week is focused on the most important number for markets worldwide: the monthly CPI inflation print in the US, out on Wednesday. Markets are expecting a further moderation in the YoY core number, and any upward surprise will make it hard for the Fed to ease in March, adding fuel to the recent dollar rally. The monthly GDP print out of the UK and a number of speeches by Federal Reserve and ECB officials will round out the week, as trading volumes pick up from the holiday torpor.

GBP: Sterling was the only G10 currency that managed to match the dollar’s rise last week, ending higher against every other major currency. Two factors are contributing to the pound’s outperformance: resilience in consumer demand, evidenced in recent economic activity data, and Bank of England relative hawkishness, which results in the highest interest rates in the G10 and a comparatively slow timetable for cuts in 2024. This week the focus will be on the November GDP report, out on Friday. Economists expect to see a healthy rebound relative to October’s contraction, which would be consistent with the rebound witnessed in the business activity PMI numbers. A technical recession as early as the final quarter of last year remains a possibility following the downward revision to the Q3 data, although we are quietly confident that this will be avoided once the official data for Q4 is released in the middle of February.

EUR: The tug of war between the European Central Bank’s apparent hawkishness and the poor economic performance in the Eurozone continues. December inflation numbers were mixed. The headline index rebounded as energy subsidies were removed, although the more important core index continued on its downward trend, and is now squarely below the ECB’s repo rate. This week, there is not a lot of economic data on the docket. Focus among investors will be on speeches by ECB officials, specially chief economist Lane, who is expected to provide clarity on the ECB´s view of recent Eurozone economic weakness and its impact on monetary policy. Financial markets continue to see a decent chance of a start to easing in the Eurozone in the first quarter, although these expectations continue to be pushed further into the future in line with the broad repricing globally.

JPY: The worst performing major currency in 2023 has begun the New Year in a similar fashion, with the yen once again trading lower against pretty much every other currency globally so far this year. Expectations for the first interest rate hike from the Bank of Japan continue to be pushed further into the future following the earthquake on New Year’s Day. Indeed, last week was the worst for the yen against the dollar since 2022, as investors bet that the powerful 7.6 magnitude quake would weigh on domestic economic activity and cause the BoJ to adopt an even more cautious stance to normalising policy. Communications from BoJ members over the holiday period were mixed. Governor Ueda hinted that a change in policy could soon be on the way during his speech on 25th December, although he somewhat tempered these remarks by saying that a policy change would not be forthcoming in January. This Tuesday’s wage growth figure could be highly important for the yen, as this data point appears to be the one that BoJ members are watching the closest when it comes to the timing of tightening. Evidence of solid earnings pressure would be welcome news for JPY, and could lead to a sharp snap back in the currency.

CHF: The franc rally after Christmas, which saw the EUR/CHF pair fall below the 0.93 mark to its lowest level since January 2015 (when the SNB abandoned its peg), was followed by some calmness. The pair ended the first week of 2024 little changed, and the Swiss currency landed in the middle of the G10 FX performance dashboard. There is little to explain the post-Christmas rally in the franc, aside from investor portfolio rebalancing ahead of year-end amid thin liquidity trading. A significant decrease in short CHF positions from deeply negative levels suggests that investors may see the currency as a useful hedging vehicle in the environment of heightened geopolitical uncertainty ahead of a busy year of elections. We believe it may be difficult, however, for the franc to hold onto its gains given the recent dovish turn from the SNB. Data out this morning on a slightly sharper-than-expected uptick in inflation at the end of the year does not change this view, particularly as both measures of price pressures remain firmly within target.

CAD: Friday’s Canadian labour report for December was the dictionary definition of a mixed bag. The unemployment rate unexpectedly remained unchanged at 5.8%, after economists were pencilling in a modest uptick to 5.9%. Wage growth also accelerated, jumping to 5.7% – its fastest pace since January 2021. On the other hand, net employment change came in effectively flat, well below the +13.5k consensus, marking the worst month of job creation since July. On balance, we tend to focus more on the impressive earnings number, as this is likely to have greater bearing on Bank of Canada policy than anything else. Clear evidence of strong wage pressures may encourage BoC members to adopt a less forceful approach to policy easing, and we see little reason for the bank to rush into cutting rates as soon as the current quarter. Swaps are currently fully pricing in the first cut in April, although this may well change should wages fail to come down in a timely manner in the next couple of labour reports.

CNY: Recent strength in the dollar has pushed USD/CNY toward the top of its recent trading band (7.10-7.20). News from China has been all over the place in recent days, although negative sentiment still dominates. Late-last week, attention was on the liquidation bankruptcy filing by Zhongzhi, a Chinese wealth manager. This was not a surprise, as the company has been struggling for some time, although it highlights the broader repercussions that the problems of the real estate sector could have on the domestic financial sector. The latest economic data was mixed, with the still very weak official PMI figures contrasting with the private data. That said, the rise in the Caixin PMI for the services sector, which expanded at the fastest pace in five months, is somewhat encouraging. Looking ahead, investors will pay close attention to financing, trade and inflation data. The latter (out on Friday) is expected to indicate continued deflation in both consumer and producer prices, the extent of which will be important in guiding further policy action.