The factors necessary for continued trading within an upward range are all present, especially given the normal US data calendar and the lack of influence from Chinese news. However, the wage growth index negotiated by the European Central Bank is a key test for the euro. We believe that lower payroll pressure could help unwind more EUR long positions. In Sweden, the Riksbank's dovish shift seems a bit premature
US Dollar: Markets are not optimistic about the interest rate cut in China
Today US markets opened after a quiet Monday for global markets. US stock index futures are trading quietly, and the US calendar is unlikely to cause a major move today. The main index for January is the only release scheduled for today, and things will be fairly quiet on the US macro front until the FOMC meeting minutes are published tomorrow evening.
China was in focus again this morning as banks cut their five-year base lending rates by a record 25 basis points to 3.95% overnight, the first such move since June. This type of monetary easing generally has a greater impact on the real estate market, but once again the markets showed little enthusiasm. The Chinese Yuan is challenging the strong momentum of the US Dollar this morning, but the gains are very limited. As we reported in yesterday's Forex Daily, news of strong Chinese New Year travel data also created a modest positive impact on markets, underscoring that the outlook for a rebound in China's growth sentiment will be gradual at best.
The latest data from the Commodity Futures Trading Commission (CFTC) shows that the dollar is generally oversold against emerging markets and overbought against G10 currencies among speculators. This clearly reflects the markets' favoritism towards currencies that are attractive to carry trading, and indicates that the dollar remains too expensive to be continuously shorted against advanced, low-yielding currencies.
However, the view that US data will change at some point, that the Fed will cut interest rates, and that the dollar will fall remains a consensus view (and often translates into selling US dollar rallies). We prefer a strong dollar in the near term as US data remains supportive, but this seems to be the perfect recipe for range trading. For the dollar index, the 104/105 range may hold in the short term.
Euro: Wage growth of less than 4.5% will affect the euro
Things are not as calm in the Eurozone as they are in the United States today. The European Central Bank intends to publish the Eurozone-wide wage index for negotiated wage rates for the fourth quarter, which at this stage is one of the most important data inputs for the Governing Council. The European Central Bank's latest meeting put wage growth at the center of the fiscal policy debate, signaling how interest rate cuts could be ruled out unless negotiated salaries move convincingly in the right direction.
There is no published consensus for forecasts. We believe that our economic team's expectations that the reading will be around 4.4-4.5% on an annual basis is moderately lower than expectations. This wage index has been rising steadily since mid-2022, and the ECB should welcome this decline, even if it is not impressive. It will be up to the first-quarter 2024 GDP data (which includes detailed wage information) in April and the negotiated wage index in May to highlight or refocus on interest rate cuts in June, given that the second-quarter GDP numbers will be published. After the June meeting.
The same speculative positioning data mentioned above tells us that the euro is an outlier in the G10, struggling in moderately overbought territory (+7% of open interest) against the dollar despite a broadly negative interest rate spread. Some adjustments in trading positions to the downside should be observed today for the EUR/USD pair, if ECB wage growth comes in below 4.5%. However, we would not be surprised to see good support at 1.0700.
Krone: The Riksbank's dovish game looks risky
Prospera inflation expectations surveys in Sweden this morning had no impact on the market, as they were broadly in line with the recent trend. The 1-year CPI (CPIF) forecast fell further from 2.0% to 1.9% last month, the 2-year forecast held steady at 1.9% and the 5-year forecast (that's a small surprise) rose from 2.0% to 2.1%.
Yesterday's inflation report revealed that the Consumer Price Index (CPIF) rose more than expected (from 2.3% to 3.3% y/y), although core inflation fell in line with consensus from 5.3% to 4.4%. The Riksbank has recently turned pessimistic in its rhetoric, even indicating the possibility of lowering interest rates in the first half of the year. The larger-than-expected increase in the headline Consumer Price Index (CPIF) suggests that optimism about declining inflation may have been premature.
More importantly, we believe that the easing guidance introduced in February may end up being counterproductive. This is because - as the Riksbank itself has admitted - avoiding a weakening of the krone remains crucial in the inflation battle, but at the same time early easing guidance (combined with the end of foreign exchange sales) puts the krone in a fragile position if sentiment turns negative for For foreign currencies with a high beta coefficient. We therefore believe that EUR/SEK could trade above these levels in the short term, but the Riksbank may be prepared to sell back foreign currencies if the Swedish krona weakens too much. Our medium-term forecast for the pair is a break below 11.00, but again we believe that the Riksbank's monetary policy may add obstacles to the Swedish krona's recovery path.
Canadian Dollar: Deflation retreat
Canada releases January inflation numbers today, and consensus expectations are for core data to hold at 3.6% y/y. The headline CPI is expected to decline from 3.4% to 3.3% y/y, with an increase of 0.4% m/m after December's encouraging reading of -0.3% m/m.
The expected slowdown in the disinflation process is in line with developments in the United States and other major countries, and does not raise significant concerns for the Bank of Canada, which estimates the headline inflation rate at 3.2% in the first quarter of the year. However, a tight labor market and a postponement of the date for the Fed's first rate cut means the Bank of Canada is likely to opt for patience on more accommodative guidance at upcoming meetings. That is, unless today's CPI numbers surprise significantly to the downside.
USD/CAD could find further support in the coming weeks as we expect the US dollar to remain strong with risk sentiment fragile. The scenario of a return to last week's highs 1.3585 seems appropriate at the moment. However, we still expect lower US dollar interest rates to unleash bearish potential for the pair in the second half of the year, even with the Bank of Canada cutting interest rates at the same time as the Fed.
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