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USD: Inflation may stay too hot

The second round of post-election Trump trades has now taken the DXY dollar index to the 2022 highs as markets sink their teeth into the dual narrative of a wider rate and growth gap between the US and other developed countries. The latest news on the government appointment side is that Elon Musk and Vivek Ramaswamy will lead a “department of government efficiency”, which aims to slash bureaucracy and spending. It is too early to tell what this will effectively mean for public finances, but this confirms that Musk will play a key advisory role in the Trump administration, which likely fuels expectations for de-regulation and looser taxation.

The strong dollar is currently pricing in a good deal of Trump’s policy mix, and data releases/dovish Fed comments might offer good opportunities to take profit in bullish dollar positions. However, our house view for today’s US inflation report is that core CPI kept rising at a consensus 0.3% MoM in October, and headline CPI at 0.2%. This is above the 0.17%MoM rate that needs to be averaged over time to hit the 2% inflation target, and should keep markets on the dovish side of the pricing for the Fed.

Still, pricing is already quite cautious on further Fed easing, with only 15bp priced in for December and 23bp by January. This means there is probably an asymmetric downside risk for the dollar today in case of a slightly lower-than-expected core CPI print. There are also a few Fed speakers to monitor today: Kashkari, Williams, Musalem and Schmid.

If we are right with our CPI call, then the dollar rally could find a bit more steam and DXY consolidate above 106. Nevertheless, the recent bullish move is starting to look a bit stretched, and the risk of a positioning-led short-term USD correction similar to the 7 November one is quite high.

EUR: 1.06 is in line with rate gap

EUR/USD has remained under intense pressure from a broad USD rally and may well make a move below 1.06 today if the US core CPI comes in at 0.3% MoM. Despite the size of the recent EUR/USD drop, we must note that 1.060 is the short-term fair value level implied by short-term rate differentials. The USD:EUR two-year swap rate gap has continued to widen rapidly, and is currently around 185bp.

In other words, there is not much additional risk premium being added to EUR/USD compared to what rates are suggesting, as markets are doubling down on expectations that the ECB will slash rates more than the Fed ahead of the tariff impact on growth.

We are, by all means, in the dovish camp with our ECB call, and actually think markets are still underpricing (30bp) the chances of a 50bp cut in December.

The eurozone calendar is quite quiet today and US news will drive EUR/USD. A stretched positioning argues for some short-term upward correction in the pair, but as per the USD section above, we don’t expect this to happen today given a still-hot US CPI. Regardless of short-term adjustments, the direction of travel is bearish for EUR/USD, in our view, and we target 1.04 for year-end.  

GBP: Eyes on Mann today

The main event in sterling markets today is a speech by Bank of England’s Catherine Mann, the most hawkish member of the MPC. Markets will be attentive to any comments about the implications of the recent budget for monetary policy and any colour on the latest jobs/wage figures. Given her arch-hawkish stance, we suspect she could stress – if anything – the inflationary aspect of the government’s spending boost and perhaps focus more on the sticky wage figure rather than the rise in the unemployment rate in September.

Ultimately, the GBP curve does not need many more hawkish hints to move at this stage. Markets are pricing little to no chance of a cut in December, and only 50bp in total by September 2025. In our view, the risks remain skewed towards a dovish repricing and consequent negative impact on sterling, although a repricing lower in rates may take some time to materialise as markets will tread carefully when assessing the inflationary implications of the budget. The soft momentum for the EUR means EUR/GBP could remain close to the 0.8300 gravity line.

CEE: Stronger dollar pulls CEE down further

The market has almost ignored the inflation numbers over the last two days within the CEE region and the global story seems to be in the spotlight still.

Today will not be much different. The calendar offers current account numbers for September in Poland, the Czech Republic and Romania. Those produced a positive surprise last month in the Czech Republic and a negative one in Poland, which the market could watch this time around to see if it was a one-off or a trend reversal.

However, the main story remains the declining EUR/USD which should keep pressure on the CEE currencies. We remain bearish here. If anything we see PLN outperforming the region but perhaps later rather than sooner, however yesterday EUR/PLN bounced off 4.360 which seems like a key level. While HUF seems like a separate story now PLN/CZK may get the market's attention given the bounce back from 5.800 which seems like a limit to PLN's weakness here and could get some support.

Markets turning more hawkish on the Fed

US rates are moving higher, and this might be the path of least resistance in the coming days, given Trump's victory and the potentially hotter CPI and PPI figures on Wednesday and Thursday.

Markets are continuing to pare back their Fed rate easing expectations. A cut in December is just about a 50/50 probability event in the eyes of the market. The SOFR futures strip bottoms out just above 3.80% and only around late-2026 to mid-2027. The broader Treasury curve, ie, 2s10s has resteepened somewhat, also driven by resuming issuance activities of the wider market.

Overall we are still in a bit of limbo in terms of the timing and impact of Trump's policies. This state where we move from pricing promises to looking at actual policies might last for some months, and in the meantime we think there is still a chance that data will sour and trigger a (temporary) leg lower in rates. But we need to see that cue from the data first.

Euro rates continue to diverge from the US

Looking at the eurozone, we see an ongoing divergence compared to the US. Following the disappointing ZEW reading, front-end rates pushed lower, including pricing for a potentially even larger 50bp cut by the European Central Bank in December.

The 2y ESTR OIS rate tested the downside and is now slightly below last week’s level, while the US 2y SOFR rates increased by 9bp after the Monday holiday. The EUR back end couldn’t fully escape the global trend of rising rates on Tuesday when the US markets reopened. The 10y ESTR OIS rate is now up by 1bp following Tuesday’s late rise, but the spread to SOFR has widened by 9bp to over 170bp – the widest since late 2019.

Where things start to get a little clearer is the timing of elections in Germany after the recent government turmoil – a confidence vote is now slated for 16 December with new elections expected to take place on 23 February. The 10Y Bund has already stabilised over the past few days at around 1-2bp above the 6m Euribor-based swap rate. While the above swaps levels are a first for Bunds, we have made the point before that when comparing to OIS – a largely risk-free rate expectations measure – the currently observed levels “merely” represent a return to the pre-QE situation of 2014.

Wednesday’s events and market view

The US CPI numbers will draw the most attention, with the core CPI expected to come in at a relatively hot 0.3% month-on-month. US CPI numbers triggered sharp global rate reactions over the summer, but more recently the focus has shifted to growth concerns. Later in the day, we have several Fed speakers, including Musalem from the St Louis Fed who will speak about the economy and monetary policy.

In terms of issuance, Italy will auction 3Y, 6Y, 8Y and 15Y BTPs for a total of €8.25bn. Germany has scheduled a 10Y Bund for €4bn, and Portugal a 10Y and 20Y OTs totalling €1.25bn. The UK will be auctioning £4bn of new 3Y Gilts. 

Line graph showing various measures of inflation and the Federal Reserve's policy rate of interest.

Source: Reuters

Markets

US bond yields surged after having had the day off on Monday for Veteran’s Day. Net daily changes varied between 8.7 and 13.1 bps across the curve spectrum as President-elect Trump’s reflationary politics continue to reverberate. Expectations for a (much) looser fiscal policy lift those for US growth at a time when CPI inflation has yet to hit the 2% central bank target.

With Germany now having set the election date at February 23, we’ll be looking for the fiscal narrative to gain traction in the country and more broadly in Europe as well. US CPI not being at target will still have been the case in October. Numbers are released later today. Headline inflation is seen to accelerate from 2.4% to 2.6% y/y. Core inflation would match September’s 3.3%. Any beat, however small, would cast further doubt on another December 25 bps rate cut. Markets already pared the odds sharply to about 60%.

Minneapolis Fed Kashkari yesterday said that “if we saw inflation surprises to the upside between now and then, that might give us pause” when asked what could cause the Fed not to cut rates next month, deviating from the September dot plot. Kashkari is live commenting at Bloomberg when the CPI numbers come out. Stock markets succumbed to the yield pressure. Wall Street eased off the record highs, the Dow Jones underperforming.

Europe’s Stoxx50 slipped 2.25%. A technical acceleration kicked in after the index lost support around 4800. Widening interest rate differentials (European swap rates rose between 0.7-4.6 bps) and the risk-off created the perfect environment for the USD. The greenback strengthened once more against all major peers. EUR/USD tested the 1.06 big figure. It avoided a break yesterday (1.062) but continues to trade on the backfoot this morning (1.061), suggesting ongoing, by default dollar strength. USD/JPY extends its meteoric rise that’s been going on since mid-September to beyond 155 currently. We expect to see some Japanese government and central bank officials to become increasingly vocal about the matter.

Gilts underperformed Bunds on “sticky” (BoE chief economist Pill) wage growth but sterling couldn’t benefit. Perhaps the UK currency is eying other important data that’s upcoming, including Friday’s GDP numbers and next week’s CPI. EUR/GBP jumped back above 0.83 but the technical picture remains a fragile one.

News & Views

The Federal Reserve Bank of New York consumer survey showed households’ inflation expectations declined slightly across the whole spectrum of horizons in October. One-year ahead inflation expectations eased 0.1%pt to 2.9%, three-year ahead expectations declined 0.2%pt to 2.5% and the 5-y gauge softened to 2.8%. Home price growth expectations (3.0%) were unchanged and stayed in a tight band since August 2023.

Labor market expectations improved with households reporting a lower likelihood of higher unemployment (-1.7%pt to 34.5%, the lowest since Feb 2022) and personal job loss (-0.3%pt to 13.0%). Consumers see a higher likelihood of finding a job if they were laid off. Median expected household income growth as unchanged at 3.0%. That was also the case for spending growth 4.9%, but this parameter stays well above pre-pandemic levels. Perceptions of credit access compared to a year ago improved in October. The average perceived probability of missing a minimum debt payment over the next three months decreased by 0.3%pt to 13.9%, the first decrease since May 2024. Perceptions about households’ current financial situations compared to a year ago improved.

Australian quarterly wage growth figures for Q3 for the third consecutive quarter printed at 0.8% Q/Q. The Y/Y measure eased to 4.1% to 3.5%. The rise was slightly more modest than expected. Annual growth in the private sector was 3.5% in the September quarter 2024. This is the lowest private sector annual growth since the September quarter 2022. Public sector annual growth (+3.7%) was higher than in the same quarter last year (+3.5%), but lower than the recent peak (+4.2%) seen in December quarter 2023. The Reserve bank of Australia expects wage growth to ease to 3.4% at the end of the 2024 and 3.2% end 2025.

However, for these kinds of wage growth levels to be compatible with inflation sustainably returning to 2-3% a further rise in productivity is probably needed. Money markets currently still only fully discount a first RBA rate cut in the summer of next year. The Aussie dollar remains under pressure from USD strength (AUD/USD 0.6525) but in this move recently outperformed the likes of the euro (EUR/AUD 1.626).

Source: ACTIONFOREX