FX Daily: Short-term rates argue against another big USD leg lower

In yesterday’s FX Daily, we argued that the heavy lifting to a dollar recovery was likely hinging on more US activity data resilience but that a hawkish pushback by the Fed and higher oil prices were two other potential channels of dollar support. Personal spending, PCE and initial jobless claims were in line with consensus, but the large OPEC+ output cuts announced in the afternoon after soft eurozone CPI figures favoured a rotation away from Europe back into the dollar.

Our feeling is that investors' positioning on the dollar had started to be stretched on the short side and that eurozone inflation was the trigger for a positioning adjustment but not a game-changer for the EUR/USD outlook. Short-term rate differentials unequivocally pointed to a weaker EUR/USD before the EZ inflation.

ISM manufacturing for November will be in focus today. The FX market is set to remain highly sensitive to any activity data point, but there is a sense dollar bulls have survived the consumer spending and PCE risk, so that today’s ISM figures may not have a big impact – barring any big surprises. Incidentally, the notion that the manufacturing sector is in contraction is well established by now.

We expect some dollar consolidation in the coming days, with still upside risks as the greenback reconnects with its rate advantage.

Francesco Pesole

As discussed in the dollar section above, we don’t see the eurozone inflation numbers as an excessively important event for the EUR/USD prospects. Market pricing had already given up on any rate hike expectations, and the bulk of the ECB dovish repricing is still due to the deteriorating growth outlook rather than disinflationary bets.

Markets are now pricing in a first ECB cut in April, and further dovish repricing will become harder from this point on. However, that won’t be necessary to put pressure on EUR/USD if short-term differentials reconnect with the pair. The 2-year EUR-USD swap spread is now at 178bp the lowest since December 2022, when EUR/USD was at 1.05.

Today, the focus will be on a speech by ECB President Christine Lagarde. She will probably continue to hang on to some hawkish arguments to limit rate cut bets, but the efficacity of this line of communication remains questionable.

Francesco Pesole

Elsewhere, EUR/CHF has seen some sharp losses this week to dip below the 0.95 mark. There have been no obvious drivers of this relatively large move, meaning that month-end position adjustment – seemingly broad selling of the euro – is left to get the blame. Looking ahead, we do not see the case for a substantially lower EUR/CHF. Yes, the Swiss National Bank (SNB) has been driving it lower through FX sales, yet we argue that the SNB’s desire for a stronger Swiss franc will wane.

This is because the inflation differential to major trading partners is narrowing quickly and means less need for a stronger Swiss franc to keep the real exchange rate stable. We tend to think EUR/CHF will hover around the 0.95 level for most of next year. Were EUR/CHF to fall too sharply, the SNB would probably flip from being an FX seller to an FX buyer.

Chris Turner

Yesterday was an eventful day for the Canadian dollar. GDP figures for the second quarter were revised sharply from -0.2% to +1.4% (quarterly, annualised), and the third quarter saw a -1.1% contraction. The negative impact on CAD was rather short-lived, though, as the announcement of large output cuts by OPEC+ spurred oil-sensitive currencies.

Today, the focus is once again on domestic data, with the release of November labour statistics. The consensus is for another respectable employment read (+14k), and we don’t have a strong argument against that except for the fact that hiring numbers can be quite volatile. Some focus will be on whether full-time roles will be filled again after last month’s increase in headline payrolls was driven entirely by part-time.

The tightness of the labour market continues to be a concern for the Bank of Canada, as policymakers pointed to lingering inflationary risks in the October statement. We doubt Canadian unemployment is bound for a sharp rise in the near term, but the pressure on the BoC to soften its hawkish bias is mounting anyway. As discussed in our BoC preview (ahead of the 6 December meeting), the growth outlook is concerning not just due to the backward-looking GDP figures, but especially given the high sensitivity of Canadian households to high rates.

Our call is for 150bp of cuts in Canada next year, but the near term outlook for the loonie remains strictly tied to US data, with which it is highly correlated. We feel 1.35-1.37 is the range for USD/CAD into year end.

Francesco Pesole

Today, we have the busiest day of the week in the CEE region. This morning already saw the release of Hungary's third-quarter GDP data, including the breakdown. Later we will see the same data in the Czech Republic. We will also see PMIs across the region for November. In Hungary, the Government Debt Management Agency will publish the funding plan for next year at 10:00 am local time. It seems that the funding assumption will be a government deficit of 2.9% of GDP, which was approved by the government. However, we expect the deficit to be increased and the strategy updated later.

In the Czech Republic, the outcome of the November state budget will be published. The latest numbers showed an improvement and today's number could help us estimate how much the Ministry of Finance will have to issue in terms of bonds for the rest of the year. In Poland, S&P will publish a rating review after the close of trading. We don't expect any changes here, but it will be interesting to see the commentary on fiscal policy after the October elections.

CEE FX erased basically all of this week's gains yesterday after EUR/USD returned to 1.090, which took over as the main driver. However, after yesterday's correction, the CEE FX relationship with rates should resume again as it has in recent weeks. From this perspective, we see gains for PLN and CZK today. Both currencies reached record-high interest rate differentials yesterday thanks to a larger drop in core rates, which should benefit FX. For EUR/PLN, we see levels below 4.340 and EUR/CZK below 24.250. EUR/HUF, on the other hand, should stabilise in the 380-381 band.

Frantisek Taborsky