Dollar's Defensive Rally Stalls: Soft Labor Data Takes the Edge Off
In yesterday's FX market, a notable shift occurred as US interest rates reacted to softer-than-expected labor market data. This week's adjustment in the Fed's terminal rate expectations has effectively dampened the potential for a defensive dollar rally. As a result, the dollar may be vulnerable heading into next week's US jobs data release.
Calm Returns to Asset Markets: Fed's Role in Market Support
Financial markets seem to have found a temporary respite, with precious metals showing modest gains, equity futures recovering from their lows, and Bitcoin attracting buyers. This market support could be attributed to the belief that the Federal Reserve is poised to step in again. The one-month USD OIS priced one year forward has dropped 12 basis points this week, approaching 3.00%. This move suggests that the Fed's policy rate is being guided towards the lower end of the neutral range, as estimated by most analysts. The adjustment in Fed pricing was influenced by surprising soft US labor market data released yesterday, which contradicted the Beige Book survey evidence provided to the central bank ahead of its January meeting. This will likely intensify focus on the December NFP jobs report, due next Wednesday, which includes annual benchmark revisions.
US Tech Stocks: A Potential Dip?
It's challenging to predict whether US tech stocks will experience another significant decline. What we can say is that longer-term, cyclically adjusted price-earnings ratios for the S&P 500 are nearing multi-decade extremes, and the buy-side appears fully invested. Nvidia, the poster child of the AI stock rally, is nearing major support levels at $164-169. These levels warrant close attention.
Dollar's Performance: A Missed Opportunity?
Interestingly, the dollar's performance during this recent corrective period could be considered subpar. The DXY rally to 98.00 might be a sufficient move for now, and chasing higher may not be advisable.
University of Michigan Consumer Sentiment: A Key Indicator
Today, keep an eye on the February release of the University of Michigan consumer sentiment numbers. These figures have been attempting to rebound after a significant drop in April. Any unexpected dip here could have a mild negative impact on the dollar, serving as a reminder of consumer dependence on stock market performance.
Japan's Election: A Volatile Outlook
Elsewhere, the market appears positioned for a long USD/JPY ahead of Sunday's election in Japan. The outcome should be known by the time of the Asia opening on Monday, and volatility is expected. For more insights, refer to our preview.
EUR/USD: ECB's Stance on Euro Strength
At the European Central Bank's press conference yesterday, President Christine Lagarde made it clear that the ECB is not considering rate cuts in response to euro strength. Her remarks, along with some stability in asset markets and the softening of short-dated rates, have helped EUR/USD find support under 1.18. Support at 1.1770 has held so far, and any dollar selling activity at big fixings could indicate a reduction in dollar exposure by European investors.
German Data: A Mixed Bag
Today, the eurozone calendar features the release of the ECB survey of professional forecasters at 10:00 am CET. German data has been mixed, with December industrial production coming in weaker than expected at -1.9% month-on-month, but the trade balance surprising on the upside. Overall, these developments are not expected to alter the view that EUR/USD could hold support at 1.1770 again today.
Swiss Franc: A Rising Safe-Haven
The Swiss franc remains exceptionally strong, having become the safe-haven of choice due to its large current account surplus, net foreign asset position, and superior budgetary position. Should US tech stocks take another leg lower, we could see a pair like AUD/CHF fall quickly.
Bank of England: A Dovish Surprise
As my colleague, James Smith, mentioned yesterday, the Bank of England's decision to vote 5-4 for unchanged rates was more dovish than expected. Market expectations now marginally favor a rate cut in March, but the second quarter is seen as a more comfortable timeframe for pricing the next move, when evidence of lower inflation should be clearer. We, too, favor a March cut.
However, the market struggles to fully price two 25bp cuts this year, likely due to political considerations. Any leadership challenge to PM Keir Starmer and a presumed leftward shift in policy setting could leave the Gilt market vulnerable and delay a BoE easing cycle. Notably, 30-year UK Gilt yields ended the day higher yesterday, despite the dovish BoE communication.
We see potential for sterling to withstand this strain, and we expect EUR/GBP to find support at 0.8670/80. Over the next month, our bias is towards 0.88 as political pressure remains on Starmer and data gradually strengthens the case for a March BoE rate cut.
Czech National Bank and National Bank of Poland: A Busy Day
Yesterday was an active day for the Czech National Bank (CNB) and the National Bank of Poland. The CNB received more attention this time around. Inflation data showed a decrease from 2.1% to 1.6% year-on-year, in line with expectations, but the market had positioned for a lower number, leading to a rates repricing even before the CNB decision later in the day. As expected, rates remained unchanged at 3.50%, but the market was initially concerned by the hawkish forecast. Later, attention shifted to the governor's dovish tone, confirming discussions about potential rate cuts.
Due to higher-than-expected inflation in January, our economists have revised their rate cut call from March to May. EUR/CZK peaked in the range 24.350-400, which has been our target since the beginning of the year. Given the market's expectations, this can be considered a peak, with a potential reversal downward.
For now, 24.250-300 seems reasonable, in line with the rates' reaction, and we await more details from the CNB analyst meeting today.
The National Bank of Poland's press conference did not reveal much new information compared to January. The governor reiterated that March could be a suitable moment for a rate cut, aligning with our forecast. However, we anticipate more downside for inflation than the NBP's forward guidance suggests. Therefore, we continue to expect a rate cut to 3.25% as the terminal rate this year, with some downside risk. EUR/PLN approached 4.230 but did not break the upper edge of the current range. The press conference did not bring any game-changing insights, so we can expect EUR/PLN to remain within the range of 4.200-230.
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