Photo by Austin Distel on Unsplash
 

What was noticeable yesterday was that US interest rates did seem to react to some softer labor market data. This week's re-pricing lower of the Fed's terminal rate has therefore taken the sting out of a potential defensive rally in the dollar. This could leave the dollar vulnerable into next week's US jobs data. And the ECB seems comfortable with EUR/USD.
 

USD: A little calm returns to asset markets

Some temporary calm seems to have returned to financial markets, where precious metals are modestly higher, equity futures are off their lows, and Bitcoin has found some buyers. Supporting markets may be the view that the Federal Reserve is ready to run to the rescue again. Here, the one-month USD OIS priced one year forward has fallen 12bp this week towards 3.00%. That would mark the Fed's policy rate being taken to the lower end of most estimates of the neutral range. Helping that adjustment to Fed pricing was some surprisingly soft US labor market data released yesterday – at odds with the Beige Book survey evidence provided to the central bank ahead of its January meeting. This will bring increased focus on the December NFP jobs report released next Wednesday, which includes annual benchmark revisions.

It's very difficult to say whether US tech stocks will have another large leg lower. All that can be said is that longer-term, cyclically adjusted price earnings ratios for the S&P 500 are near multi-decade extremes, and the buy-side looks fully invested. The poster child of the AI stock rally, Nvidia, is also near some pretty major support levels at $164-169. These need to be watched.

Arguably, the dollar should have performed better during this recent corrective period. The DXY rally to 98.00 might be enough for the time being, and we would not want to chase it higher.

For today, look out for the February release of the University of Michigan consumer sentiment numbers. These have been trying to rebound after April's big drop. Any surprise dip here could prove a mild dollar negative in that it would serve as a reminder of consumer dependency on stock market performance.

Elsewhere, it looks as though the market is positioned long USD/JPY ahead of Sunday's election in Japan. The outcome should be known by the time of the Asia opening on Monday, and volatility looks assured. Here is our preview.
 

EUR: ECB doesn't stand in the way of EUR/USD rally

At the European Central Bank's press conference yesterday, President Christine Lagarde made it reasonably clear that the ECB was not on the precipice of cutting rates in response to euro strength. Here is what she said: "And in the last few weeks – actually since the summer – it has fluctuated within a range. And whether you look at the euro/US dollar or whether you look at the nominal effective exchange rate, the story is the same. So as a result of that observation, we concluded that the impact of exchange rate appreciation since last year is incorporated in our baseline."

Those remarks, some stability in asset markets and the softening of short-dated rates have all helped EUR/USD find support under 1.18. Support at 1.1770 has so far held, and we would look out for any dollar selling activity at big fixings – e.g., the London 4:00pm GMT WMR fix – if the European buy-side really is preparing to pare back its dollar exposure.

On the eurozone calendar today is the 10:00am CET release of the ECB survey of professional forecasters. And we have already seen mixed German data: December industrial production came in weaker than expected at -1.9% month-on-month, but the trade balance surprised on the upside. Nothing to change the view that EUR/USD could hold support at 1.1770 again today.

Elsewhere, the Swiss franc remains incredibly strong. It has fast become the safe-haven of choice, driven by its large current account surplus, net foreign asset position, and superior budgetary position. Should US tech take another leg lower after all, we could see a pair like AUD/CHF fall quite quickly.
 

GBP: Dovish BoE was a surprise

As my colleague, James Smith, wrote yesterday, the Bank of England was more dovish than expected in voting 5-4 for unchanged rates. Market expectations have now shifted to marginally favouring the next cut in March, but remain more comfortable in pricing the next move in the second quarter when the evidence of lower inflation should be clearer. We favour a March cut.

Yet the market struggles to fully price two 25bp cuts this year – probably because of politics. Any leadership challenge to PM Keir Starmer and the presumed leftward shift in policy setting would leave the Gilt market vulnerable and could delay a BoE easing cycle. Notably, 30-year UK Gilt yields ended the day higher yesterday, despite the dovish BoE communication.

We see plenty of room for sterling to take the strain here and would look for EUR/GBP to now find support at 0.8670/80. Our bias over the next month is towards 0.88 as political pressure remains on Starmer and data slowly adds to the case for a March BoE rate cut.
 

CEE: Marching on the spot

Yesterday was busy for the Czech National Bank and the National Bank of Poland. The CNB probably received more attention this time. Inflation in the morning showed a decrease from 2.1% to 1.6% year-on-year, in line with expectations – but the market was positioned for a lower number, and so we saw rates repricing even before the CNB decision later in the day. As expected, rates remained unchanged at 3.50%, and the market was initially spooked by the hawkish forecast; later, the attention switched to the governor's dovish tone, which confirmed the discussion about rate cuts. Due to higher inflation in January compared to our expectations, our economists changed their rate cut call from March to May.

EUR/CZK peaked in the range 24.350-400, which has been our target since the beginning of the year. Given that we cannot expect the market to go for two cuts in the near future, this can be considered a peak and a reversal down again. For now, 24.250-300 seems fair in line with the reaction in rates, and we will wait for more details from the CNB analyst meeting today.

The press conference of the National Bank of Poland did not bring much new information compared to January. The governor reiterated that March could be a good moment for a rate cut, in line with our forecast. At the same time, we see more downside for inflation than the NBP's forward guidance suggests. Therefore, we continue to expect a rate cut to 3.25% as the terminal rate this year, with some downside risk. EUR/PLN approached 4.230 but did not break the upper edge of the current range. At the same time, the presser did not bring anything game-changing, so we can expect EUR/PLN to remain in the same range of 4.200-230.

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