10.01.23: Federal Reserve Policy Debate Will Drive Near-Term Sterling and Euro Moves against the Dollar
There will be further uncertainty over the Chinese outlook with reports that the rapid reversal of the countries coronavirus strategy has caused a surge in domestic infections. This surge will maintain reservations over potential mutations and, given the relaxation of border controls, there could also be significant global implications.
Federal Reserve policies and the US economy will still tend to dominate in the short term with market expectations that the US central bank will not be able to sustain the hawkish policy stance.
There will tend to be a battle between the Fed and markets with near-term US data releases very important.
In this context, there will be caution ahead of the latest US inflation data on Thursday.
The overall risk tone is likely to be more positive in the short term with an important element of buying on dips for equities while the dollar is likely to see selling interest on any significant rallies.
Overall confidence in the UK outlook remained fragile on Monday and the currency failed to gain support from relatively hawkish comments from Bank of England chief economist Pill.
Pill stated that UK inflation was liable to remain higher than in other countries, especially with a tight labour market and supply difficulties.
Dollar weakness dominated for much of the day with the Pound also gaining support from firm risk appetite as equities posted gains. The Pound to Dollar (GBP/USD) exchange rate posted further gains to 2-week highs just above 1.2200.
Risk appetite was less confident on Tuesday with further uncertainty over global demand conditions as China embarks on a rapid U-Turn surrounding the coronavirus strategy.
GBP/USD retreated to near 1.2150 as overall Sterling confidence remained fragile and the dollar attempted to regain territory.
Markets will monitor comments from Bank of England officials and developments surrounding strikes will also be significant for underlying confidence.
Overall, equity markets will remain a key element with scope for short-term GBP/USD support on dips towards 1.2100.
There was a further net support for the Euro on Monday with expectations for a recovery in the Euro-Zone economy.
Gas prices remained close to 2022 lows which maintained an element of relief and the ECB is expected to raise interest rates further to curb inflation.
The Euro-to Dollar (EUR/USD) exchange rate hit 7-month highs at 1.0760 before a limited correction to 1.0730.
Data releases will remain of secondary importance in the short term with markets monitoring energy prices and developments in Ukraine.
EUR/USD sentiment will remain firm in the near term, especially if it can hold above 1.0700.
The dollar came under renewed pressure on Monday amid expectations that the period of US out-performance is coming to an end.
San Francisco Fed President Daly stated that there had been no evidence that core inflation outside housing had shown signs of coming down and that it is too soon to declare victory and stop rate hikes. She added that it was reasonable for rate to increase to 5.25-5.50% and that a hike of 25 or 50 basis points was realistic for the February meeting as she warned against ruling out a 50 basis-point hike.
Markets overall were unconvinced that the Fed would be able to maintain a very hawkish stance given evidence of weakening inflation pressures.
In this context, traders are pricing in over a 75% chance of a 25 basis-point rate hike at the February meeting.
Increased confidence in the Chinese and Euro-Zone outlook also sapped potential dollar support.
The dollar index dipped to 7-month lows before finding some relief with dollar to yen (USD/JPY) exchange rate support below 131.50.
Fed rhetoric curbed dollar selling to some extent and Danske Bank still expects that the Fed will be determined to stay in a hawkish mood which will trigger a dollar rebound.
It notes; “We still favour Fed to hike 50bp in February with the main arguments being a still tight labour market, a likely rebound in core CPI looks to around 0.3-0.5%m/m and hawkish Fed comments recently.
Danske adds; “Hence, we see potential for EUR/USD to revert lower over the coming weeks,”
The yen initially remained under pressure on Monday with the Pound to Yen (GBP/JPY) exchange rate posting 2023 highs around 161.20 before a retreat to 160.50 on Tuesday.
The latest data recorded a recovery in Australian consumer confidence to the highest level since September 2022.
The Australian dollar held firm, but was unable to make further headway later in the day with the Pound to Australian dollar (GBP/AUD) exchange rate recovering from 7-week lows at 1.7500 to trade around 1.7615.
The Pound to Swedish krona (GBP/SEK) exchange rate traded close to 2-month highs just above 12.75 on Monday before a limited retreat to 12.65.
Norwegian inflation data was mixed with the headline rate declining more than expected to 5.9% from 6.5%, but the underlying rate edged higher to 5.8% from 5.7%.
The Pound to krone (GBP/NOK) exchange rate settled around 12.06.
Markets will be monitoring rhetoric from central bank speakers during Tuesday with Fed Chair Powell due to make comments during the day.
Overnight, the Australian monthly inflation data for the fourth quarter is scheduled for release with expectations of an annual increase of 7.2%.
Overall risk conditions will remain important with further uncertainty over developments in the Chinese economy.
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Tim Clayton
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Daily FX 10.01.23: Federal Reserve Policy Debate Will Drive Near-Term Pound Vs Euro, Dollar – Exchange Rates UK
