Inflation and Monetary Policy

The Euro’s Struggles

Outlook and Strategic Implications

The US dollar is expected to maintain its upward momentum unless there is a substantial shift in macroeconomic conditions or Federal Reserve policy signals. Nevertheless, its current positioning makes it vulnerable to short-term corrections. For the euro, the combination of cautious ECB policymaking and ongoing market pressures points to continued weakness.

Trump 2.0: Two key questions as markets second-guess the initial reaction

USD: Some well deserved consolidation

FX markets are seeing some well-deserved consolidation after a volatile few weeks. The near 7% DXY appreciation in just six weeks had been one of the sharpest adjustments in FX markets since the summer of 2022. As Francesco Pesole noted yesterday, positioning is probably the biggest threat to the dollar right now, although we may also start to hear of dollar seasonality again where DXY has fallen in eight of the last 10 Decembers and for the last seven consecutive Decembers. 

With the US data calendar quiet this week, attention remains on the make-up of President-elect Trump's cabinet. One of the most relevant positions for financial markets is the post of US Treasury Secretary. This has yet to be decided, but it seems there are at least four names in the running: Kevin Warsh (ex-Federal Reserve), Marc Rowan (Apollo Global Management), Howard Lutnick (CEO of Cantor Fitzgerald), and Scott Bessent (Key Square Group). Some reports even have Robert Lighthizer as still being in the mix for this position. The relevance of the pick for financial markets will probably be how the US Treasury market reacts. A candidate with proven reliability will be well-received by the bond markets, while those with less experience – or perhaps a candidate that will offer less of a counterweight to some of President-elect Trump's plans – could see the long end of the US Treasury market sell-off and perhaps even soften the dollar too.

DXY is currently holding support just above 106.00 and even a correction back to 105.65 would still keep the near-term bullish trend intact. We see no reason for a large dollar correction at the moment, but equally not a clear catalyst for an advance.

EUR: Brief reprieve after some hawkish comments

EUR/USD is enjoying a brief correction as some of the ECB hawks speculate over whether global fragmentation (i.e. shortening of supply chains and trade wars) will be inflationary and will call for higher interest rates. These were the thoughts of ECB's Joachim Nagel yesterday – comments which helped narrow the two-year EUR:USD swap differential by around 10bp and saw EUR/USD correct to 1.06.  

On the subject of rate differentials, the market currently prices 10bp of Fed cuts in December (we look for 25bp) and 31bp of ECB cuts (we look for 50bp). Of course, if the Fed cuts 25bp and the ECB only cuts by 25bp, there could be a little upside for EUR/USD amid the seasonal dollar patterns we discuss above.

For the time being, however, we do not see a compelling case for EUR/USD to correct much higher and even a move to 1.0660/65 would still be in keeping with a bearish near-term trend. Expect another quiet day for EUR/USD with a focus on the US Treasury pick, as discussed above.

CAD: October CPI figures will be important

Canada releases inflation figures for October today. Expectations are for a rebound in headline CPI to 1.9% YoY while core measures are seen stabilising around 2.4%. This is the last CPI report the Bank of Canada will see before the 11 December meeting, meaning the release can have deep implications for market pricing, which currently embeds nearly even chances of a 25bp or 50bp cut.

The other two major inputs for the BoC will be GDP data on 29 November and the November jobs report on 6 December. We still see a 25bp move as more likely as both activity and inflation seem to be stabilising and markets have scaled back some Fed easing expectations. We see a case for some modest tightening in the USD:CAD 2-year swap rate gap from the current 100bp level, which can put a cap on USD/CAD in the near term. We still expect the pair to end the year below 1.40.  

HUF: How hawkish can the NBH be?

Today's meeting of the National Bank of Hungary should be a non-event in terms of a rate decision. Central bankers have made it clear that the cutting cycle is on hold for some time due to high financial instability, meaning too high a EUR/HUF. Numbers from the economy continue to surprise on the downside, with third-quarter GDP confirming a return to technical recession and headline inflation surprisingly holding close to the central bank's target. In fact, Hungarian headline inflation is the closest to the target among CEE peers at the moment. However, the central bank's focus is on EUR/HUF which has repeatedly broken above 410.

Although the market was still pricing in rate hikes in late October and early November, these expectations have calmed since the US election and the market has rebuilt some rate cuts into the longer horizon of the FRA curve. Still, the NBH does not appear to have won. While market positioning is less short on the HUF than before the US election, the market still sees EUR/HUF heading more to the upside. So the NBH will have to show enough hawkish rhetoric today to be able to return EUR/HUF to more acceptable levels.

At the same time, the NBH will want to avoid any hints of an additional rate hike or other stronger measures. EUR/HUF briefly returned to 410 yesterday but surprised with a reversal below 407 at the end of trading. Visibly the market is looking for a way to go. However, we believe 410 will remain the point of gravity in the current global environment, which the NBH does not fully control – namely the negative for the entire CEE region led by EUR/USD pushing lower.

Markets

US Treasuries followed last week’s recipe. Testing the recent low (area; depending on the maturity), but eventually rebounding higher. This time without strong trigger though like Thursday’s Powell speech or Friday’s retail sales. The move seemed more erratic in nature. Timing didn’t fit with the release of second-tier, but consensus-beating US figures. NY Fed services business activity rose from -2.2 to -0.5 in November, with details showing strength in business activity and employment.

Both in the current and 6-month forward looking subindex. The NAHB housing index recorded a third consecutive increases to a 7-month high, from 43 to 46. The 6-monht sales outlook reached the highest level since April 2022 on hope on looser regulation and more construction during president Trump’s second tenure. Yesterday’s price action strengthens our short term consolidation call as dust settles over the US presidential elections, in absence of important eco data and with the Fed not in a hurry. Intraday changes on the US yield curve ranged between -0.7 bps and -3.3 bps with the belly of the curve outperforming the wings. German Bunds underperformed US Treasuries (GE 2y: +5.4 bps) in what could be the start of an opposite (to US Treasuries) consolidation phase. EUR/USD profited from relative yield dynamics with the pair being squeezed from 1.0531 to 1.0598.

Dovish Greek ECB member Stournaras labelled a December 25 bps rate cut a done deal and added that it’s an optimal reduction. That way, he dented more aggressive market bets calling on a 50 bps move (25% probability). This week’s eco data have the potential to completely close the door obviously depending on their outcome. The ECB built her recent reaction function on what her president Lagarde calls “the three criteria”: the inflation outlook, the dynamics of underlying inflation and the strength of monetary transmission.

Tomorrow, we receive important info on the second pillar via Q3 negotiated wage data. Annualized wage growth remained between 4.3% and 4.7% from Q1 2023 to Q1 2024. Last quarter’s decline to 3.5% was welcomed by the ECB in its inflation fight, but remains way above the central bank’s 2% inflation target. ECB Lagarde indicated that forward-looking wage trackers point to a an easing of pay growth in 2025 which she hopes to see reflected in tomorrow’s numbers. On Friday, EMU November PMI’s are expected to paint a similar, dire, picture as in October (50 for composite). Recall though that there was a serious discrepancy between weak Q3 soft data and hard data (+0.4 Q/Q EMU GDP growth).

News & Views

ECB chair Lagarde in yesterday’s “The economic and human challenges of a transforming era” speech again called for a(n effective) single market for both goods and capital in order to reverse progressively slowing productivity. “By acting as a union to raise our productivity growth, and by pooling our resources in areas where we have a tight convergence of priorities – like defense and the green transition – we can both deliver the outcomes we want and be efficient in our management of public spending.” Lagarde stressed the need for such changes given the two megatrends that are challenging the bloc’s economic model. The first is a new geopolitical landscape. An increasingly inward-looking global environment is a hazard to the open European economy.

The second is Europe falling behind in emerging technologies, specializing mostly in technology developed the last century. Lagarde said the innovation and financing ecosystems are not suited to develop new advanced technologies, noting that about a third of EU savings sit in cash and bank deposits compared to around one-tenth in the US. She floated an amount of up to €8tn that could be redirected into long-term investments if EU households were given better opportunities to invest their savings. The still-existing trade barriers within the EU’s single market for goods and capital are estimated to represent a shortfall of around 10% of the EU’s economic potential.

San Francisco Fed economists in research published yesterday said that the US labor market is still adding to inflationary pressures, be it less than in 2022 and 2023. “Declines in excess demand pushed inflation down almost three-quarters of a percentage point over the past two years. However, elevated demand continued to contribute 0.3 to 0.4 percentage point to inflation as of September 2024.” The findings offer some counterweight to Fed chair Powell’s observation back in the summer, when he said that the job market is no longer a source of significant inflationary pressures.

Source: ACTIONFOREX