It was a little surprising to see the dollar generally lower on Friday. Interest rate markets priced a more hawkish Fed on the back of the December jobs data, yet the dollar still fell. This week's release of US December CPI should add more ammunition to the hawkish Fed story and we would expect the dollar to play its role in tightening US monetary conditions.
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USD: Dollar to play its role in tighter monetary conditions
It was a little surprising to see the dollar edged lower on Friday despite quite a sharp adjustment in US interest rate markets. As James Knightley writes, the December NFP will probably only add to the Fed's fears over inflation. Indeed, Fed Funds futures contracts now price the chances of a 25bp Fed rate hike at the Jan 26th meeting at around 85% - compared to 65% pricing at the start of the year. That the market is pricing in close to 100bp of tightening over the next twelve months is startling compared to the story the Fed was telling us a year ago that no hikes would be forthcoming until 2024.
We probably should not spend too much time trying to explain why the dollar went lower on Friday - maybe it has something to do with $-based global equity and debt investors using the post NFP liquidity to put money to work overseas. And early portfolio flow data this year does tend to show flows having picked up into the EM space - especially into products like Taiwanese equities.
Instead, let's focus on the week ahead which on Wednesday sees the US December CPI release. Here headline and core inflation is expected to push through 7% and 5% YoY respectively and should add to expectations that the Fed sounds more hawkish at the January FOMC meeting - preparing the market for a March rate hike?
With US 10 year yields looking at the risk of pushing through the 1.75/80% area (there is US$100bn of Treasury supply this week), we would continue to back the dollar and see DXY heading back to the 96.50 area over the next couple of days. We'll also be hearing from a couple of Fed hawks tomorrow, George and Mester, but more importantly, we'll hear Senate testimony from Powell as part of his re-nomination process. This should keep the hawkish narrative alive.
EUR: Focus on the Schnabel speech
EUR/USD remains supported within its 1.1180-1.1380 range, having rallied on Friday. This morning Euro-watchers are dissecting a weekend speech from Isabel Schnabel suggesting that energy transition will pressure inflation and could see the ECB's inflation forecasts revised higher. The next set of ECB forecasts will be released at the March 10th ECB meeting. Raising inflation forecasts, - e.g. the 2023 and 2024 closer to or to 2.00% could see expectations build of earlier ECB tightening - something we currently price in for March 2023.
For the time being, however, the clear and present danger for tighter policy clearly comes from the US right now and we would prefer to back the dollar in 1H22. Favour EUR/USD grinding back towards the 1.1300 area and staying offered into Wednesday's US CPI release.
Elsewhere, Norway has already released higher-than-expected December CPI today, which will support the case for a hike at the Jan 20th Norges Bank meeting. Favour EUR/NOK retesting support at 9.93/94.
GBP: Decent November UK GDP should help tomorrow
GBP remains well-supported and like others has taken advantage of the softer dollar environment post-NFP. We are looking for a decent November UK GDP release tomorrow of 0.4% MoM, which should keep expectations alive of a further BoE rate hike on February 3rd. Currently, OIS markets prices an 80% chance of a 25bp hike.
We continue to favour EUR/GBP drifting towards the 0.8270/80 area, while Cable may struggle to break strong resistance at 1.3600.
RUB: Handle with care
There is much focus on security discussions this week between Russia and the West in order to address tension in eastern Ukraine. Talks take place with the US today (Geneva) and then move to Brussels for discussions with NATO on Wednesday and subsequently with the OSCE.
We doubt expectations of any 'break-through' are high. e.g. it will be difficult for NATO to promise that it will refuse to accept membership applications from the likes of Georgia and Ukraine. Yet we see the RUB holding its recovery from last week's USD/RUB spike high at 77.30. And as Russian exporters return from their New Year holidays, we favour USD/RUB returning to the 73-75 range - backed by a very hawkish Central Bank of Russia and 3m RUB implied yields at 8.5%.
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