FX Daily Strategy: N America, December 12th

Some USD downside risks on US CPI

USD/JPY and CAD/JPY looks the most vulnerable

EUR/USD upside limited given widening short end spreads

GBP gains may be reaching their limit

US CPI is the main data on Tuesday, but there is also UK labour market data as an appetiser before the main course of the US data.

We expect November CPI to be unchanged for a second straight month, though ex food and energy we expect a 0.3% increase to follow October's 0.2% rise. Before rounding however we expect a core rate of 0.26%, meaning that a second straight 0.2% rise is more likely than 0.4%. This is a more important number than usual given the FOMC meeting on Wednesday. The market is expecting a slightly more hawkish Fed after the solid US employment data on Friday, but more evidence of slowing inflation could be expected to tilt expectations more dovishly. Market consensus is in line with our forecast, so we would see risk to the downside for yields and the USD.

We still see USD/JPY as the most vulnerable pair to lower US yields, as in spite of the impact of the reports on Monday on the JPY, yield spreads still point firmly to a stronger JPY. The reports suggested that there would be no rate hike in December, but that shouldn’t be a surprise. Ueda’s comments that boosted the JPY last week didn’t suggest an imminent tightening, but indicated that the BoJ were planning for an exit from ultra-easy policy next year. The JPY sell off on Monday may not reverse quickly, but there is a danger of a JPY rally on any more hawkish BoJ language next week. In the meantime, USD/JPY, and particularly CAD/JPY, look to have rallied too far based on modest moves in yield spreads.

While EUR/USD might get a boost if US CPI is on the soft side, it still looks a little extended based on current spreads, with the 2 year US/German spread reaching a 1 year high on Monday above 2%. However, any softness in CPI will tend to help riskier currencies via a positive equity impact as well as yield spread effects, so downside for EUR/USD is likely to be limited ahead of the data. But on as expected numbers, we would favour the EUR/USD downside and a possible test of 1.07.

The UK labour market data was modestly on the weak side of expectations. Average earnings growth was below expectations both excluding and particularly including bonuses. The claimant count rose again, and the more up to date HMRC data showed a decline in employment and a further decline in pay growth, as well as a small m/m drop in payrolled employment.

GBP hasn’t shown much reaction, but the numbers may convince one or two of the three hawkish MPC members that a further rate hike is not necessary given these declining trends in employment and pay. We have October GDP data tomorrow which may also have an impact on thinking. But the current pricing of policy expectations through 2024 already has a big widening in the policy rate spread between the BoE and the ECB, and it is hard to see this widening further, We consequently see the EUR/GBP risks as weighted to the upside unless tomorrow’s UK GDP data show a significant upside surprise.