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The dollar remains bid as the market continues to question whether the Fed needs to cut rates to 3.00/3.25% after all. Also helping the dollar may be tight money market conditions as the US Treasury restocks its cash balances. In the absence of official data, the focus this week will be on insights into the US job market from private sector releases.
 

USD: Focus on money markets

Risk currencies are not seeing the typical boost one would have expected after the US and China agreed on a one-year trade truce last week. We think there are two factors currently at play keeping the dollar the dominant story.

The first is the market reconsidering the extent of the Federal Reserve's easing cycle after last week's press conference from Chair Jerome Powell. Here, the probability of a 25bp December rate cut has dropped to 66% and could fall further depending on this week's US data. The focus now will be on what private sector data tells us. Today sees the ISM manufacturing release for November, which contains the employment component. It's not clear if we will see the JOLTS job opening data tomorrow, but on Wednesday, the monthly ADP jobs release will be a big market mover – and probably the biggest chance of the week for the dollar bear trend to restart.

All this comes as we learn more about the 'strongly differing' views amongst Fed participants on whether it was right to cut rates. On Friday, we heard from two officials, Lorie Logan and Beth Hammock, who said they would have dissented against last week's Fed cut if they had had a vote. They both rotate onto the policy-setting FOMC next year. For this week, there seems to be a broader mix of Fed doves and hawks speaking.

Our second factor keeping the dollar bid is the tightness in US money markets. With its quantitative tightening, the Fed has been reducing bank reserves this year, and the US Treasury has also been rebuilding its cash stockpile (The Treasury General Account) from $300bn to $950bn. From an environment of surplus liquidity, it now seems that US money market conditions are tighter – exemplified in Friday's data showing banks took down $50bn in overnight funding from the Fed's Standing Repo Facility. Banks have paid 4.00% for this, when market rates are meant to be in the middle of the Fed's 3.75-4.00% range. Tight money markets normally keep the dollar supported, and we'll be watching to see whether this difficulty in accessing dollar funding extends internationally into the cross-currency basis swap, e.g., banks swapping euros for dollar funding. This would be quite EUR/USD negative if seen, but there are no signs of that yet.

Expect DXY to hang around near the top of its three-month range near 100.00/100.25, unless insights from the US jobs market can reprice a December Fed cut back to 100%.
 

EUR: Volatility collapsing

Traded volatility levels from the FX option market can signal whether investors are actively taking a view or passively folding their cards on existing positions. Three-month traded EUR/USD volatility continues to sink and is now below 6%. It's hard to see what will stop this from falling to the summer 2024 lows of 5.30%. Combined with the three-month EUR/USD risk reversal dropping back to flat (from a 1% skew for EUR/USD calls in May) is a sign that EUR/USD bulls have just about given up. Market consensus is for 1.18 by year-end. We think EUR/USD could rally slightly more than that on a dovish Fed – but those views are under pressure.

Expect the dollar story to continue driving EUR/USD this week. However, in the eurozone, we do get a heavy slate of European Central Bank speakers. This starts with Chief Economist Philip Lane at 1:00pm CET today. ECB rhetoric looks unlikely to help EUR/USD, however. The debate leans more towards whether eurozone inflation undershoots and the ECB requires another rate cut.

We suspect that 1.1500 could prove the bottom of the EUR/USD range this week, though that will require some softer US jobs data to provide some breathing space.
 

GBP: The rate cut debate heats up

Financial markets are getting excited about a Bank of England rate cut potentially as early as this Thursday. A couple of big investment houses have recently switched their call to a move this week. And from just a 6% probability of a rate cut this week, which was priced at the start of October, the market now attaches a 29% weight.

As our UK economist James Smith writes here, we think the BoE will prefer to wait for the contents of the Autumn Budget later this month before making its next move. And with the UK terminal rate already priced at 3.25% for next summer, we find it difficult to justify a much lower pound on the back of an under-priced BoE easing cycle. EUR/GBP could come a little lower this week if the BoE retains some of the hawkishness discovered this summer. But we suspect buying interest returns in the 0.8730/50 area. Please see our budget scenarios for sterling here.
 

CEE: NBP to cut rates, CNB continues to wait

With the beginning of the new month, fresh fuel will be added to the local story in the CEE region.

Today, PMIs will be published across the region, likely showing a mixed picture. In Turkey, October inflation will be released, and we expect a decrease from 3.2% to 2.0% month-on-month, below market expectations, resulting in a decrease from 33.3% to 33.0%. Finance Minister Mehmet Simsek admitted on Friday that the slower pace of disinflation and reaching the end-of-year target will be difficult.

On Wednesday, October inflation will be published in the Czech Republic, where we expect a slight increase from 2.3% to 2.4% year-on-year. In Poland, the central bank may cut rates again by 25bp to 4.25% after Friday's surprise drop in inflation.

On Thursday, the Czech National Bank will most likely leave rates unchanged at 3.50%, and attention will be focused on the new forecast and forward guidance. The CNB will also hold a key press conference, and we will see some hard data from both the Czech Republic and Hungary.

On Friday, the CNB will meet with analysts to present the details of the new forecast.

On the political side, the Czech Republic's new government will sign a coalition agreement today, the details of which were leaked to the media on Friday. It seems that the government will introduce several measures to reduce inflation in the short term, while the public finance deficit should remain unchanged. We may hear more details today. On Friday, Prime Minister Viktor Orban will meet with US President Donald Trump in Hungary, where we may see some headlines regarding energy imports from Russia.

We saw some weakness in the Polish zloty emerge on Friday following Poland's lower-than-expected inflation reading, and the reaction here seems justified. The market is pricing in around 3.60% as the terminal rate, which seems like the current low for the story, and the risk seems more on the hawkish side if anything. EUR/PLN seems to be returning to the previous range of 4.240-270. The Czech koruna is still flat, but Friday's spike in market rates suggests some room for gains ahead of Thursday's CNB meeting below 24.300 EUR/CZK. On the other hand, the CNB is more balanced these days, and rate hike bets may see some cooling, with a negative impact on FX.

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