FX Weekly Update: Anticipating Central Bankers' Impact on Resilient Markets

FX Daily: Waiting on central bankers to shake data-resistant markets

Investors have cemented Fed easing expectations despite some hotter-than-expected US data. We suspect a market reluctant to price out rate cuts will need strong words from the Fed – perhaps Powell himself – to reconnect rate expectations with data. Meanwhile, USD may stay rangebound. This week, Lagarde will speak in Davos, and UK CPI should slow further.

 

USD: Rate expectations still disjointed from data

The first half of January has shown a dislocation between rate expectations and data in the US. The two most important data points for the Federal Reserve, labour and CPI inflation figures, both came in hotter than expected. PPI was a bit softer than consensus on Friday, but that is not enough to justify markets’ reluctance to price out Fed easing. The Fed funds future curve prices in 21bp of cuts in March, and 168bp by year-end.

Our view remains that the Fed won’t start cutting before May, and that the total easing package will be 150bp. Accordingly, the rally in short-term USD rates appears overdone, and weakness in the front part of the USD curve should support some recovery in the dollar. However, we suspect that the data may prove insufficient to trigger a USD rebound for now; the consensus view of a dollar decline later this year seems to be making investors keen to sell dollar rallies. Also, the Fed probably needs to send a clearer message that the latest data does not justify the kind of aggressively dovish view embedded in money market pricing. There are a few more Fed speakers lined up this week, but perhaps dollar bears will want to hear it from Fed Chief Jerome Powell, who is not scheduled to speak until the 31 January FOMC announcement.

Incidentally, the US data calendar isn’t very busy this week. Retail sales and the University of Michigan inflation expectations will attract the most attention along with jobless claims - which came in well below expectations last week, reinforcing the narrative of a still-tight labour market. We think the dollar will be driven more by other events than data this week, barring major surprises. First, the results of the election in Taiwan have raised again the delicate question of Taipei-Beijing relationships, with tensions among the two seen as a major risk for Asian and global risk sentiment this year. The dollar might benefit from some outflows from exposed EM FX. The situation in the Gulf also looks rather volatile after the US and UK military operations last week, even though the impact on oil prices has been muted so far.  

Domestically, we’ll monitor the market reaction to the business tax relief extension currently being discussed in the US Congress. The impact of fiscal support may turn out to be negative for risk sentiment – and positive for the dollar – as markets see a greater risk of sticky inflation and a lower chance of Fed rate cuts.

We think the dollar is more at risk of a rebound than a further correction from these levels, although the chances of another rangebound trading week in FX (DXY still hovering in the 102/103 region) are high.