The turning tide
View from the Trading Desk:
Unless you've been living under a rock, it's very likely that the unprecedented wave of US Dollar strength will have caught your attention at some point over the past 12 months. In fact, the move higher in the trade-weighted Greenback has been going since January 2021, peaking at a 28.5% gain in September 2022. This translated to an all-time low of 1.0350 on GBP/USD and a multi-decade low of 0.9536 on EUR/USD. While the cause of the Dollar's strength was clearly linked to both geopolitical risks and a slew of bumper interest rate hikes from the Federal Reserve—in response to decades-high inflation—the difficulty has been in trying to call the end of the move.
Last week, we got a glimpse into the thinking inside the Federal Open Market Committee when the minutes of their November meeting were released. The report was surprisingly 'dovish', with widespread agreement that the pace of hikes needs to be slowed until the cumulative effects filter through the economy, which is now more likely to enter recession next year. Between the 21st and 28th of November, market expectations have also shifted, as investors now expect rates to peak below 5%, and many are betting that the Fed will be forced to cut rates in early 2023. To us, it looks as though more FOMC committee members are turning dovish with risks to the US economy tilted to the downside. Just look at last week's Purchasing Managers Index data for evidence of the headwinds to financial conditions. This shift has undoubtedly been a driver of recent Dollar weakness.
Meanwhile, the outlook for other major economies hasn't particularly become more attractive; however, it's becoming more and more evident how much the bad news was priced in. So much so that any hint of optimism in thinner liquidity conditions has been leading to sharp price action. While the outlook is certainly tilting towards more Dollar downside, we must play devil's advocate. Option sentiment remains heavily skewed towards those protecting against Sterling and Euro weakness in the coming months, with plenty of risks around both inflation and energy security still prevalent in the region.
Bottom line: Despite little positivity in the UK and Eurozone, we're currently trading around three-month highs on GBP/USD and five-month highs on EUR/USD presenting a good opportunity for those looking to take advantage of the recent move. On the flip side, it's worth remembering that rates for these pairs are still 12% and 10% lower than the January peak and well below long-term averages. This gives you an opportunity to achieve better value for your Dollar than practically at any point in recent memory.
The week ahead
Sterling is trading 1% higher on a trade-weighted basis over the last week as UK courts disallowed Scotland from holding an independence vote, lifting risk sentiment. Political divisions continue in the Conservative Party, with the hot topic currently being the issue of onshore wind farms. A mounting number of Tory MPs and the Labour Party fully support the repeal. This could create a headache for the Prime Minister, who faces the difficult challenge of keeping the party onside while navigating the country through a cost-of-living storm. Recent BOE policymaker comments echoed the market mood of further rate increases to come as real wages look set to decline 7% in the next two years.
- UK Mortgage Approvals are forecast to hit 60.0K in October versus 66.8K in September.
- Monetary Policy Committee members Catherine Mann and Huw Pill are scheduled to speak this week.
- Bank of England Governor Andrew Bailey will testify on Tuesday before the Lords Economic Affairs Committee.
- The Nationwide House Price Index MoM for November is projected to read -0.4% for the month of November as house prices continue their trend lower.
The Euro has continued to strengthen this morning against the US Dollar, trading just shy of the $1.05 handle, a five-month high. Traders have increased bets that the European Central Bank will hike interest rates higher than 50 basis points at its December meeting. Current odds suggest a 50% chance of a larger hike following strong PMI data out of Germany and France last week. ECB comments have also been hawkish, with Council member Klaas Knot suggesting the central bank is not close to ending its hiking cycle as yet, with price risks to the upside still prevalent in European economies.
- European Central Bank President Christine Lagarde is due to speak today and Friday.
- Eurozone flash CPI and Core CPI YoY will be released on Wednesday, with analysts expecting a 10.4% and 5.0% print, respectively.
- German Retail Sales MoM for the month of October are projected to decline by 0.6% versus 0.9% in September.
- The Unemployment Rate in the Eurozone will print on Thursday; markets anticipate a 6.6% reading.
The Bloomberg Dollar Index has declined 1% since the start of trading last week as traders continue to unwind long positions in the global reserve currency. Gold has gained today as heightened Covid tensions in China have a knock-on effect throughout markets. Federal Reserve Chairman Jerome Powell will speak on Wednesday and will likely remain firm on the central bank's policy of strong rate increases. Some on the Federal Open Market Committee are beginning to tilt to a more dovish stance, however, with a wider range of views likely to reveal themselves in the coming months as inflation shows signs of easing. US equity futures are lower this morning as stocks decline on the last Monday of November.
- The Conference Board Consumer Confidence Index will publish data for November on Tuesday; forecasts are for a 99.9 print.
- Inflation data will be released on Thursday, with the Core PCE Price Index MoM expected to clock in at 0.3% for October.
- The ISM Manufacturing PMI for the month of November is projected to read 49.8.
- On Friday, Non-Farm Payrolls data is expected to read 200K in November versus 261K in October.
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