The undisputed winner in currency markets last week was the Japanese yen, which soared as the Bank of Japan finally hinted that it is ready to start normalising monetary policy. The other theme in FX was the rebound in the dollar, as US interest rates rose on the back of a very strong labour report, which suggests that the Federal Reserve will not be cutting rates any time soon. The dollar subsequently rose against every G10 currency, save the yen. Special mention to yet another strong performance by Latin American currencies, which managed to buck the trend towards a stronger dollar and added to their scorching 2023 performance.
This week promises to be packed with action. We start on Tuesday with the release of the most important economic report worldwide: US inflation for November. The last meeting of the year for each of the major central banks will follow: the Fed on Wednesday, and the ECB and the Bank of England on Thursday. Finally, the PMIs of business activity for November will be released in most of the world on Friday. By the end of this week, we should have a much clearer picture of where the economic, inflationary and monetary trends will be going into 2024. Brace for volatility.
An unusually busy week awaits sterling. The December meeting of the Bank of England will be preceded by two key macroeconomic releases: the labour market report (Tuesday) and the monthly GDP print (Wednesday), both for the month of October. Economists are expecting a modest easing in wages in the former, with the latter set to show modest contraction in the UK economy in October. The MPC is expected to leave interest rates unchanged on Thursday, although we think that it will try to push back against market pricing of a full cut in the first half of 2024. The voting split among committee members will also once again be key. This vote was split 6-3 in favour of no change in November and could remain unchanged this time around as the bank reinforces its stance of higher rates for longer. We think both data and central bank communications are likely to be supportive of the pound, underlining the story of demand resilience and high wage growth that should keep UK rates elevated for longer than elsewhere.
Last week saw yet more dismal news on the Eurozone’s economy. German factory data for October underperformed already depressed expectations, as did Eurozone retail sales for the same month. This provides further evidence to markets that a recession in the bloc in the final quarter of the year is increasingly likely, which has acted to hold back the common currency in recent trading sessions. Indeed, EUR/USD ended the week around its lowest point in about a month. The European Central Bank is universally expected to stand pat at its December meeting on Thursday, although the key to the announcement will be the extent of the push back against market expectations for a cut as early as March of next year. While this is much earlier than expectations for other central bank cuts, the bad economic news does seem to justify a cautiously dovish ECB policy, as long as the disinflationary trend continues.
It is hard to exaggerate the extraordinary resilience of the US economy in the face of the fastest hiking cycle in history. The November jobs report surprised to the upside and suggested that the labour market continues to fire on all cylinders, with job creation, unemployment and wage growth all stronger-than-expected. Bond yields backed up moderately and the dollar rebounded after the data, although markets are now focused on this week’s inflation report, followed by the Federal Reserve meeting. A pause in the disinflationary trend followed by Fed pushback against market timing for cuts (which is now running well ahead of the Fed’s own “dot plot” forecasts) could support the dollar next week. We expect FOMC chair Powell to reiterate the strength of the US labour market, while saying that a period of below-trend growth will be needed for the bank to meet its inflation mandate. This may be enough to suppress market expectations for US rate cuts, which continue to appear excessive.