FX Daily: Time To Think About The Midterms?

The ECB sent a clear message yesterday: a December hike is likely. That is providing a more supportive backdrop for the euro ahead of today’s 3Q GDP release. Meanwhile, resurgent AI-related jitters and the upcoming US midterms are increasing downside risks for the dollar, in our view, although a still-hawkish Fed argues against major corrections.

We see some precautionary unwinding of net-long positions ahead of Tuesday’s US midterm election as the main risk for the dollar today.

USD: Midterm positioning may start to kick in

Fresh pressure on tech stocks has triggered some safe-haven buying in US Treasuries and weighed on the dollar as the front end followed lower. Moves are contained in both equities and FX, but it’s a reminder that the greenback still faces downside risks from oscillating AI sentiment.

At the same time, whenever tech stocks don’t dominate headlines, the dollar has had no trouble attracting buyers, and we don’t think Wednesday’s FOMC changed that. Incidentally, yesterday’s US data was hawkish-leaning, with 3Q growth slightly above consensus at 3.4% and core PCE at 0.3% month-on-month in September – enough to keep the Federal Reserve on high alert.

To us, the main risk for the dollar today is some precautionary unwinding of net-long positions ahead of Tuesday’s US midterm elections. A Democratic sweep is trading around 68% in prediction markets, and that could be seen as slightly negative for the US dollar from a few angles, from higher risk of government shutdown and gridlock on debt ceiling negotiations to potential damage to already shaky AI-related sentiment. We’d be cautious in chasing the USD upside in the next few days.

Today marks the end of the FOMC’s blackout period, and we’ll hear from Thomas Barkin (neutral), Mary Daly (moderate dove) and Alberto Musalem (moderate hawk). But we don’t feel there is much members can add at this stage, as markets are already pricing in a December hike and dovish comments look unwarranted given the latest energy price developments.

EUR: ECB to keep tightening going

The euro went on a small rollercoaster yesterday as the European Central Bank held rates. The statement initially came across as slightly dovish, with a reference to financial conditions weighing on inflation and growth. But President Christine Lagarde then delivered a few hawkish remarks in the press conference that propped up the euro.

Lagarde said a hike was discussed at the meeting and hinted that the direction of travel remains towards further tightening. She also gave no indication that French bonds are prompting any dovish rethink at the ECB. Finally, the customary tip to the media a few hours later indicated that officials are “ready” to raise rates in December. That was another clear endorsement of rate expectations and has left the euro better supported.

The side note was Lagarde’s resignation, effective 7 February, which brings forward the announcement of her successor by a few months. Pablo Hernández de Cos (dove) and Klaas Knot (hawk) are the frontrunners. Should the former be announced, it could bring some downside risks to the euro.

Today, we’ll take a look at third-quarter GDP data in the eurozone. We expect a slightly stronger-than-consensus 0.3% quarter-on-quarter print. France will be monitored closely: we expect 0% growth (consensus 0.1%), and a negative figure here could cause some fresh widening in spreads.

We see a decent chance of EUR/USD re-exploring the 1.120-1.1250 area, as the dollar faces downside risks related to AI stocks and US midterms.

JPY: BoJ stays hawkish as CPI target hit

The Bank of Japan left the policy interest rate at 1.25% today and, for the first time, signalled that its 2% inflation target had been hit. Running through both the statement and the new Outlook report were three themes that the BoJ felt could all contribute to upside price risks: energy prices, AI demand and the weak yen. In that report, growth forecasts were left around 0.7-0.8% (near or above potential), while CPI forecasts were revised slightly higher.

Markets are still debating whether the BoJ will hike next at the December or January meeting, but remain confident that the policy rate will be heading up to the 2.00% area next summer.

The BoJ also gave a nod to rate hikes overseas and presumably will be aware of the risks of a weaker yen should it not track the Fed and ECB with a rate hike in December. We now think the BoJ will hike in December, with a likely follow-up in March/April.

USD/JPY is a little lower today on this hawkish hold – although the dollar is a little lower across the board. We see it staying bid towards the top of a broad 155-160 range and then turning lower in 2Q next year.

CEE: The relief rally won't last long

The CEE region will see its first important data release of the week today, with inflation figures from Poland and GDP data from the Czech Republic and Hungary for the third quarter. We estimate that Poland’s October inflation fell from 4.1% to 3.8% year-on-year, largely due to the government’s introduction of fuel price caps. However, the breakdown should be somewhat more hawkish than the headline figures, with core inflation rising from 3.1% to 3.3%.

In Hungary, we expect a slowdown to 0.2% quarter-on-quarter, alongside an acceleration in year-on-year growth to 1.7%. Conversely, in the Czech Republic, we see an acceleration to 0.6% quarter-on-quarter, but a slowdown to 1.7% year-on-year. The National Bank of Hungary projects 1.6%, while the Czech National Bank’s August forecast anticipated 2.2%; however, the Q2 figures already came in 0.4 percentage points below expectations.

The Fed and ECB meetings brought some stabilisation to CEE currencies, in line with expectations, and we saw a rally in the forint and the zloty – the first in a week. However, the market suggests that this relief will not last long.

Speculation regarding a resumption of US attacks on Iran, new highs in energy prices, and a return to a sell-off in the stock market are bringing a "risk-off" mood back into play – exerting pressure on CEE currencies, just as we anticipated. Our bearish bias remains, and the zloty appears the most vulnerable here, unless inflation surprises on the upside this morning.