We said that last week would be a volatile one, with three key central bank meetings in quick succession, and currency markets did not disappoint. The Federal Reserve executed a clear pivot towards rate cuts, both in terms of rhetoric and its actual forecasts for rates in the “dot plot”. By contrast, the ECB and the Bank of England were both hawkish, and pushed back against market expectations for rate cuts, in spite of the rather negative newsflow we have seen out of Europe recently. Financial markets celebrated the news out of the Fed jubilantly, sending stocks, bonds and just about every currency other than the dollar sharply higher.

The low-activity holiday period looms in markets. With the major central bank meetings out of the way, there will not be much data to move markets. Central bank communications will be key. For the first time in a long while, there appears to be a surprising gap in outlook between the Fed on the one hand and European policymakers on the other. This gap runs in the opposite direction to that between economic performances across the Atlantic, as the US economy continues to grow, while the Eurozone appears to be contracting again. In addition to getting further clarity on this puzzling contrast, this week will see inflation data out of the UK (Wednesday) and the US (Thursday).

GBP

We had quite a hawkish surprise from the Bank of England last week. Three of the nine MPC members again voted to hike rates, as they did in November, and the bank did not change its forward guidance, saying that it was prepared to raise rates again should inflation prove ‘persistent’ This is significantly at odds with the cuts priced in by markets. Sterling rallied sharply afterwards, and it got a second wind against the euro the next day, following the release of some surprisingly good PMI readings, which suggests that Britain’s economy was accelerating as year-end approaches. A sharp improvement in the services subindex suggests that the UK economy is growing again and will avoid a recession, the opposite from the Eurozone trend. A hawkish central bank and improving economic sentiment should provide solid support for the pound in the coming weeks.

EUR

The European Central Bank stuck to its guns last week, with Lagarde saying that now was not the time to lower its guard, and that policymakers had not even discussed the possibility of lower rates. These hawkish communications were not particularly well timed. The very next day, the key PMIs of business activity for December surprised to the downside, following broad based slowdown in activity in Germany and France. A dismal reading well into contractionary territory seems to confirm that the Eurozone has entered into a technical recession in the second half of 2023. The euro gave up around half of its post-Fed gains on the news. Regardless of ECB rhetoric, we think it will be difficult for the common currency to break convincingly higher until we see a sustained turn for the better in Eurozone economic pessimism.

USD

The dollar is whipsawing, driven by two opposite forces: the apparent dovish pivot executed by the Federal Reserve, and the relative and absolute strength of the US economy. The former was underlined last week by a “dot plot” where the median Fed policymaker increased their expectation of cuts for 2024 from one to three. The latter was confirmed by a slate of second tier reports, such as retail sales and weekly jobless claims. For now, the shock of the Federal Reserve’s turn to the dovish side carries the day, though the dollar remains sensitive to bad economic news elsewhere, as well as any sign of pushback against expectations for cuts on the part of Fed officials. We have already seen such a repel from Fed member Williams and Bostic, who have both attempted to calm expectations for imminent cuts in their remarks since last Wednesday’s FOMC announcement.