FX Weekly Strategy: December 11th-15th

Strategy for the week ahead

Central banks may lean against market expectations of rate cuts…

… but markets are likely to maintain dovish views unless US CPI is strong

There may be some scope for expectations of ECB cuts to be pared back…

…but EUR already looks expensive relative to yield spreads, so upside limited

JPY should still have scope for gains, notably against the CHF

The employment report was slightly on the strong side but still fairly close to market consensus, but allowed a modest rise in US yields after the sharp decline seen over the last month. There will still be a big focus on the CPI data this week and on the FOMC statement on the following day, but the modest rise in yields following the employment report should limit the scope for a big move on the FOMC unless we see a surprise on CPI. The statement is if anything likely to discourage expectations of early rate cuts and play down the scope for large rate cuts in 2024. But unless CPI comes in significantly above expectations, we doubt the statement will change the market's view of the likely policy path. There will be an element of “they would say that, wouldn't they”, to any attempt to play down the prospect of rate cuts.

There is likely to be more scope for reaction to the ECB and Bank of England rate decisions on Thursday. The market has priced in more aggressive ECB easing following the latest low inflation print in November and the comments from the hawk Schnabel indicating that she now saw no further need for tightening. The ECB is now priced to ease more aggressively than the Fed over the next year, which is perhaps overstating the case for ECB dovishness. But it does seem likely that the ECB will have to adopt more dovish language in this month's statement, given the data developments, so we doubt there will be a significant rise in EUR yields. There may, however, be a modest rise, as we wouldn't expect the ECB to promote the idea of the spring hike that is in the market, and this may provide the EUR with some modest support. Even so, we are starting from a position where the EUR still looks a little expensive relative to yield spreads, so any recovery may come from lower levels.

The Bank of England have been the most hawkish of the three major central banks meeting this week, and are likely to maintain this more hawkish stance with some votes for a rate hike still likely to be cast from the three hawks on the committee. The UK data has been slightly stronger of late – notably the PMIs – so even though there is evidence that inflation is falling close to target on a seasonally adjusted basis in the last few months, there is unlikely to be a major shift to more dovish mode. Even so, it seems unlikely that market expectations will move further in favour of relatively high UK rates, given the gap on policy expectations that already exists. EUR/GBP has stuck fairly close to short term spread moves of late, so given the current relatively dovish view of the ECB, the risks might be slightly on the EUR/GBP upside.

There are also policy decisions from the SNB and Norges Bank this week, but no change is expected in either. We still see upside risks for the NOK in the medium term, particularly against the SEK, but a more dovish stance this time around may prevent any short term move. We also expect no change in policy from the SNB, although the market is starting to price in the risk of a rate cut. Certainly, we see scope for the CHF to weaken from here, with the SNB having already substantially reduced its FX reserve holdings so less likely to be selling foreign currency.

The big move last week was the rise in the JPY, although it stalled a little on Friday after the big gains earlier in the week. Although the trigger had been comments from BoJ governor Ueda, the JPY rally was overdue, as yield spreads had already moved substantially in the JPY's favour. It is still the case that there looms to be scope for JPY gains on a yield spread basis, primarily on the crosses, although even against the USD there is still some downside. The clearest case for a stronger JPY is against the CHF, with CHF/JPY still close to record highs and up some 50% in the last 4 years, while 10 year yields are no longer higher in Switzerland than in Japan. This could be a trade on the SNB meeting, but there is also scope for JPY strength elsewhere. However, while yield spreads support JPY gains against other currencies, gains against the riskier currencies may require some decline in equities, as the fall in EUR/JPY we have seen now puts it broadly in line with the equity risk premium metric that EUR/JPY has followed in recent years.

Data and events for the week ahead

USA

After a quiet Monday November CPI is due on Tuesday and we expect a second straight unchanged outcome overall, but with a 0.3% rise ex food and energy to follow a 0.2% increase in October. Before rounding we expect the core rate to rise by 0.26%. Also due on Tuesday are November's NFIB survey on small business and November's budget.

November PPI is due on Wednesday, and we expect a 0.1% decline with a 0.2% increase ex food and energy. The FOMC decision follows but a change in rates from the current 5.25-5.50% range is unlikely. The tone of the statement will be sensitive to incoming data, CPI in particular. Chairman Jerome Powell will make it clear easing is not yet on the agenda but the dots are likely to move in a dovish direction, and this will sustain market hopes for easing by mid-2024.

On Thursday we expect a second straight 0.1% decline in November retail sales, with a flat outcome ex autos but a stronger 0.4% increase ex autos and gasoline. Weekly jobless claims and November import prices are due with the retail sales report with October business inventories following. Friday sees December's Empire State manufacturing survey, November industrial production and December's S and P PMIs. Here we expect marginal slippage in manufacturing to 49.0 from 49.4 and services to 50.5 from 50.8.

Canada

Canada releases October data for manufacturing shipments on Thursday and wholesale sales on Friday. Preliminary estimates were for declines of 2.7% and 1.1% respectively. November new housing starts and new home sales are due on Friday.

UK

As widely expected, the BoE kept policy on hold for a second successive meeting early last month. We see this being repeated when the next MPC decision is unveiled on Dec 14, but with a slightly clearer vote in favor of keeping Bank Rate at 5.25%, with fewer dissenters than the three who favoured a further 25 bp hike last time around. A tightening bias is likely to persist as the MPC still highlights upside risks to the inflation outlook.

UK GDP to Slide Afresh?

Source: ONS, CE

As for numbers, key labour market data, once again presented on a piecemeal basis amid continuing concerns over the accuracy of figures, arrive next Tuesday. We see more signs of a loosening, with the jobless rate already up 0.5 ppt in the last three months but where data on employment and activity will still be missing and where the ONS will make estimates based on HMRC numbers. However, the average earnings figures will be released and may still be the most closely watched and where we see regular pay growth (3 mth mov avg) slowing slightly to just under7% but the headline rate down around a full ppt to just over 7%. Regardless, with even the BoE (belatedly) casting doubt on the validity of these numbers, more attention may be paid to the PAYE pay data where a clear(er) slowing has already been seen. Coming in higher than expected, GDP rose by 0.2% m/m in the September data, a result that meant that growth in Q3 was flat. But we think that the looming October data (Wed) will exactly reverse the September rise, paving the way for an overall 0.2% q/q drop this quarter, a contrast to the small rise that the BoE looks for. Flash PMI data (Fri) may see little change but till offer a less downbeat picture as the data does not cover the heavily hit construction sector. Finally, RICS survey data may help explain that the apparent resilience seen in some gauges of house prices is masking a continued slide in transactions

Eurozone

The cumulative and sizeable rate hikes at each of the ten previous Council meeting informally ended with the deposit rate left at 4.0%at the last Council meeting in October. That (very much expected) decision was unanimous and we think both the vote and outcome will be repeated when the next ECB Council verdict is given on Dec 14. But there are several areas of interest still. First, to what degree may the (somewhat optimistic) ECB economic projections be amended and to a degree that the envisaged drop inflation to below target is brought forward from the current Q4 2025 schedule. Second, whether the sharp and (to some) surprise drop in inflation (to below ECB thinking) is seen to be an aberration or something more fundamental.

Datawise, The downturn in the euro area economy extended into a sixth month according to the November PMI, although that latest reading of 47.6 was up from October's 35-month low of 46.5 and the highest since July, it was still indicative of a solid deterioration in economic conditions. WE see little change in the December numbers due Friday. EX industrial production numbers (Wed) may show a further drop while visible trade data (Fri) show more import weakness.

Rest of Western Europe

There are key figures and events in Sweden, Switzerland and Norway. In Sweden there is the CPI update (Thu) where a clear fall is likely to just below 4% for the CPIF inflation but may be not as much as the Riksbank has factored in. IN Norway, GDP data may show fresh weakness, something that may feed into Norges Bank thinking. The Norges Bank kept its policy rate at 4.25% at its last meeting early last month. We see a repeat decision emerging from the meeting due to give its verdict on Dec 14, despite the Board having very clearly flagged a further and final 25 bp move at that last meeting. Finally, in Switzerland, the SNB paused the rate hike cycle In September and we see that decision being matched (ie the policy rate staying at 1.75%) for the quarterly policy assessment verdict due on Dec 14. If anything, the decision may be more clear-cut as growth downside risks have risen, house price inflation has dissipated while CPI inflation has fallen and undershot SNB thinking.

Japan

Mostly tier two data release for japan next week. One insightful data would be PPI on Monday, Dec 11. The decline in PPI in the past quarters seems to have lagging impact towards inflation, a sustained decline in PPI would be welcoming for lower inflation. Manufacturing Outlook on and PMIs will be overlooked.

Australia

The labor data on Wednesday, Dec 13 would be the most important release for the Aussie next week. The Australian labor market has shown resilience and remained healthy nearing the end of tightening cycle, we do no forecast the current trajectory to deteriorate significantly but should further moderate in the coming months. Consumer Confidence on Monday, consumer inflation expectation on Wednesday and PMIs on Thursday will have little impact towards the Aussie.

NZ

The Q3 GDP for Kiwi on Wednesday, Dec 13 will have the eyes of market participants. After surprisingly but marginally revising the OCR path upwards, Kiwi traders will look closely in the latest GDP report to see if the economic growth is stronger than expected and hints more inflation. We also have Business PMI on Thursday.

Highlights from the last week

U.S. November NFP Likely firmer due to returning strikers

USD/JPY Slumped on Ueda's Speech

Bank of Canada Tightening Bias Persists but is Reduced

USD/CAD Slipping on Weak Oil

RBA Continue to be data dependent

We expect a 200k increase in November's non-farm payroll, stronger than October's 150k though excluding the impact of returning strikers the data will be consistent with a modest slowing. We do however expect a correction lower in the unemployment rate to 3.8% from 3.9% and a 0.3% rise in average hourly earnings, stronger than October's 0.2%.

October's payroll saw a decline of 35k in manufacturing with 33k of that due to autos, where the monthly strike report reported that 25k were on strike. We expect a 25k increase in manufacturing in November, more than fully due to autos. October's strike report also showed 16k on strike in the motion picture industry, a strike that started in July and, like autos, should see a return to work in November's report. A final special factor in November could be a late survey and an early Thanksgiving inflating the retail sector.

Rising initial and continued claims trends however suggest some underlying slowing, and a 200k increase even with some supportive special factors would be slightly below October's 3-mopnth average of 204k and its 6-month average of 206k. We expect private payrolls to increase by 155k, with a 45k rise in government a slight slowing from three straight gains of 51k. Risk from October's revision is on the downside with the sum of state data showing only a 44k increase in employment in that month.

USD/JPY has begun in turn in late October after the Fed signals potential peak rates, which suggest yield differentials to be narrowing in the coming times when BoJ exit ultra-loose monetary policy. This week, we head from Ueda's mouth the word "exit" and sparked a JPY rally. The details within his speech is less persuading as BoJ still need wage inflation to be closer to 2% to achieve sustainable trend inflation that is the requirement for the BoJ to exit current monetary policy. Yet, it is enough to spark a rally in the JPY for the pair has been extremely streched for months.

On the chart, the consolidation above the Mon's low at 146.22 gave way to sharp break lower through the 200-day MA at 142.30 to reach 141.70 low. Subsequent bounce from the latter see prices unwinding the stretched intraday studies. However, the downside still not firm and break of the 142.30 and 141.70 support will open up deeper pullback to correct the gains from the Jan low. Lower will see room to 141.50/141.00 area. Meanwhile, resistance is at 144.00 then the 145.00 high of Jun, now expected to cap.

The latest Bank of Canada meeting provides no major surprises, with rates being left on hold at 5.0% but the BoC stating that it remains prepared to tighten policy further if needed. However a slightly more dovish tone to the statement suggests that the tightening bias has eased, and that further tightening can now be seen as unlikely.

The BoC states that economic growth stalled in the middle quarters of 2023, which gives roughly equal weight to a negative Q3 and an upwardly revised positive in Q2, appropriately with momentum stabilizing in late Q3 to suggest a broadly flat picture. However the BoC concludes that the economy is no longer in excess demand, slightly more dovish than its October assessment that supply and demand were approaching balance.

The BoC sees the slowdown in the economy as reducing inflationary pressures but maintains a cautious tone on inflation. It notes that wages are still rising by 4.5%. While noting slower October inflation it notes that shelter inflation has picked up, and sees October's core inflation measures as simply moving to the lower end of a 3.5%-4.0% range, clearly well above the 2% target.

While the BoC did no bring any surprises and suggest a more dovish tone, the fall in oil price has accerlerated ther fall in the Loonie. Despite persisting geopolitical tension, the OPEC+ decision in output cut cut seems to have driven the direction of the market as there is little signs of escalation from the Israel-Palestine conflict.

On the chart, there is still little change, as mixed/negative intraday studies extend cautious trade around congestion resistance at 1.3600. Both daily stochastics and the daily Tension Indicator are strengthening, highlighting a constructive tone and potential for a fresh test above here in the coming sessions. Subsequent focus will then turn to the 1.3640 Fibonacci retracement, where negative weekly charts could prompt fresh range trade. Following corrective gains, November losses are expected to resume. However, a close below 1.3495/00 is needed to turn price action negative and open up strong support at 1.3400.

RBA had kept the cash rate on hold at 4.35%. aligned with our forecast as latest inflation dynamics do not support more tightening. The key forward guidance statement of "Whether further tightening of monetary policy is required to ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks." stays and suggest RBA is leaving the door open to rate changes on data dependency. This dovish language seems to suggest the RBA is tilting towards not hiking anymore but will let data guide their action as they are not sure where inflation may go in a short run.

"The monthly CPI indicator for October suggested that inflation is continuing to moderate, driven by the goods sector; the inflation update did not, however, provide much more information on services inflation." It suggest the RBA is closely monitoring inflation dynamics, instead of focusing on quarterly CPI figure. The rhetoric is similar to what the RBA has been stating for the past month and they have acted accordingly to hold in the December meeting with monthly CPI moderates.

The decision remains in line with RBA's rhetoric in2023 so far after they switch be data dependent and stays patient in assessing the effect of cumulative hikes while keeping a close eye on inflation dynamics. They reinforced the hike in November with more stubborn inflation, strong economy, solid labor market and house price remain high. We maintained our forecast of terminal rate to be 4.35% with no more hikes in sight. RBA has removed previous wordings of "Inflation in Australia has passed its peak but is still too high and will remain so for some time yet."in the statement which is viewed as a dovish tilt by market participants. Yet, we do not think the RBA has a specific hawkish nor dovish take at the moment because they are simply being data dependent. But the room for RBA to tighten without significantly hindering economic growth remains minimal. The household balance sheet are restricted by mortgage cost and inflationary living pressure, while business are facing the tightest financial conditions in months, alongside peaking labor market even as the Australian economic growth being stronger than market consensus. The RBA did not change their inflation forecast and seems to be content with the trajectory of inflation by seeing 2-3 percent in 2025.