It seems that investors are starting to think that the Federal Reserve is done with rate hikes and are now starting to reduce underweight positions in risk assets, including emerging market currencies. This is negative for the dollar. Today’s US employment data will be a key determinant in determining whether this week’s new trend has strength or will be stifled by strong hiring or wage numbers.
USD: Can NFP contribute to the Fed pause narrative?
European investors face a sea of green as they survey global stock markets this morning. Decent rallies of 1% to 2% have been seen in global equity benchmarks across Europe, the US and Asia. Underpinning that move has certainly been falling interest rates in the United States, where investors are moving away from the Federal Reserve’s narrative of raising rates for longer that dominated in September and October. They now appear to be exploring the history of the Fed’s pause or peak. For reference, the price of $1 million OIS rates over two years rose from just over 3% in June to a high of 4.75% last month and has since fallen again to 4.17%.
The move in rates has surely caused investors to reduce some paid positions/long dollar positions and caused a liquidation of some favorite currency short positions in emerging markets and the commodities space. This is why we think it is doing so well and continue to see upside to a relative value trade in the region, long AUD/CNH. We also noted with interest a large drop overnight. The Korean won typically has a high beta over global stocks (but not an attractive yield) and its strong rally is a good barometer of market sentiment. With Korean foreign exchange reserves falling for the third month in a row, it appears that Korea’s foreign exchange authorities have been supplying foreign exchange liquidity to the market, as have countries like China and India (presumably along with Japan soon as well). We believe the decline in USD/KRW helps define a broad risk-on and weak dollar environment today.
US employment data due out today in October will determine whether this environment has a future. Despite the ridiculous inverse correlation with ADP (which could point to an NFP number of +350,000 today), the consensus is around +170/180,000. Investors will also want to see if last month’s +336,000 figure is revised lower. The consensus also calls for an average month-over-month revenue figure of 0.3%, but that should still bring the year-over-year rate down to 4.0%, the lowest since June 2021.
Assuming no bullish surprises today, we favor the dollar retracing its gains a bit further, especially against high-yield bonds (e.g. Mexico and Hungary), given the renewed interest in the carry trade. could fall to the 105.50/55 area today as long as US employment data is not too strong.
EUR: The market has closed the door to new increases from the ECB
Overnight, the European Central Bank’s Isabel Schnabel said the ECB cannot close the door on further rate hikes, citing fragile inflation expectations and the risk of further geopolitical supply shocks. However, the market has ruled out any further rate hikes and is looking firmly at the 2024 easing cycle. This means that even though US rates have recently fallen, two-year EUR:USD swap spreads are not have fallen significantly and probably explains why it is having difficulty taking advantage of the weaker dollar environment. For reference, it is down 1% this week and macro traders will be looking for a big move lower here as they bank on a bullish tilt in the US curve. However, given global conditions, we would favor EUR/USD towards the 1.0675/1.0700 area today, unless US employment surprises to the upside.
In Sweden, the Riksbank will publish currency hedging figures for the week of October 16-20 this morning. Foreign exchange sales figures have been quite volatile and decreased sharply from almost $1 billion to around $450 million in total in last Friday’s report. We expect another spike in foreign exchange sales today due to the poor performance in the week of October 16-20, which we believe pushed the Riksbank to increase interventionism in the foreign exchange market. High currency sales are negative for the SEK and may favor another bullish leg: we now see risks skewed towards 11.85-11.90 in the short term.
GBP: Future Guidance Returns. Is the market listening?
Yesterday’s 6-3 vote by the Bank of England (BoE) in favor of keeping rates unchanged was not a surprise. What was a surprise was the reintroduction of forward guidance, meaning that “monetary policy is likely to need to be restrictive for an extended period of time.” Clearly, the Bank of England is trying to avoid a premature easing of financial conditions that would be inconsistent with a policy that still threatens a new rise. His intervention in this case arguably had some impact on the markets where Sonia’s December 25 futures contract (which briefly rose 16 ticks that day) only ended up rising 11 ticks. This occurs in an environment of lower money market rates globally.
Investors know that central bankers use forward guidance as a tool (remember how the Fed in 2021 said rates would stay at zero until 2024?) and it looks like the next nine months will be a game of cat and mouse as Investors push for rate cuts and the Bank of England fights back. We believe the data will likely support investors and we will see upside risks to our year-end forecast of 0.8700. should do a little better today in the positive risk environment. Favor a test of 1.2250 above which 1.2335 opens.
CZK: BNC postpones the start of the cutting cycle
The Czech National Bank (CNB) decided yesterday to keep interest rates unchanged. At the same time, he presented a new forecast showing a weaker economy, lower inflation, a weaker krona and also faster rate cuts next year. While the market expected a rate cut, the central bank’s decision caused an upward revaluation of the short end of the curve; however, the belly and the end of the curve ended lower at the end of the day. They are receiving mixed signals, while the 2-year interest rate differential ended only slightly higher in favor of the Czech koruna at the end of the day. Today we are likely to see more pressure for Czech koruna appreciation in the 24,400-24,500 range, but we expect pressure for a weaker Czech koruna to return soon with more incoming data confirming a weak economy and triggering fresh bets on cuts of CNB rates.
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