Divergence from the FED. In the past week we have seen three major central bank meetings, which have caused significant volatility in global FX markets. After the FED opted for a third consecutive pause, Chair Powell all but confirmed rates have now hit their peak. The downward revisions in the FED dot plot showed the FED are now moving their attention more towards the risk of over-tightening. This is positive for the overall economy and points towards the much talked about ‘soft landing’ scenario; it is, however, bearish for the dollar. The US has the luxury of taking this stance due to the reduction in price pressures, particularly over the past 6 months. The ECB and the BoE do not have such flexibility unfortunately. While we may have seen their respective currencies strengthen last week, this came not from strong economic data, but persistent price pressures and their implications for the forward path of interest rates. Each central bank will likely have to keep rates at elevated levels longer than the FED, which is attractive for savers, but not for wider economic activity. The likelihood of the UK or Europe entering recessionary territory increases the longer price pressures hold. In summary, the short to medium-term currency picture looks good for the UK and Europe, but the broader economic picture in the US looks far stronger right now.
US DOLLAR
In the past week, we saw the US Dollar index depreciate by 1.4% against a trade weighted basket of its peers. The DXY is now trading 1% lower year to date after another volatile week.
The major news from last week came from the FED interest rate decision meeting. This came not from the interest rate decision itself, as rates were held at 5.5% as expected. The major surprise came from FED interest rate forecasts, also known as the FED dot plot. Large scale downward revisions were made in the 1- and 2-year interest rate forecasts. As a result, we saw the dollar post its biggest weekly loss since July.
Powell’s press conference after the rate announcement took a far more dovish tone than had been predicted prior. He reflected that there had been clear normalisation in price trends for goods, shelter and services with the focus now moving towards when is the appropriate time to cut rates. The FED chair noted that they would not wait until inflation reaches the 2% target before cutting rates as it would then be too late and would risk tipping the economy into a deeper recession than necessary while causing inflation to significantly under-shoot the 2% target thereafter.
The main data from last week was a slight overshoot in inflation, which now stands at 3.1% in headline and 4% in the core reading on an annualised basis. Price pressures have now more than halved year to date, hence the big swing towards discussions around rate cuts.
The FED now must toe a fine line as we head into 2024. The US economy, despite showing stronger than expected data, is also facing a slowdown in consumer and corporate economic activity. Consumer and corporate debt defaults are rising rapidly and there are other vulnerabilities still present in regional banking, commercial real estate and national debt. The unexpected change in tone from the FED suggests this is very much on their mind as we head into what is set to be a very difficult year for the overall economy.
ASIA-PACIFIC
In China we saw the Renminbi strengthen back to 7.13 vs USD last week. The strengthening came largely off the back of dollar weakness rather than strong Chinese data prints. There was a welcome 6.6% increase in industrial production, beating estimates. Missing expectations, however, were data releases for retail sales, house prices and fixed asset investment. Foreign direct investment has shown huge weakness in 2023 and is estimated to be 90% lower year on year. Markets will be looking closely at the data release on Monday, where a further 10% decrease is expected. Reports have also emerged that China may be systematically under-stating income from exports and overseas investments, which could either slightly mitigate concerning economic news in recent months, or compound it if it undermines trust in official data. Any signs of weakening data from the US could also be a catalyst for the Renminbi rebounding.
The Yen appreciated by another 1.5% last week against the US Dollar in welcome news for Yen holders. The only data releases of note showed strong expansion in the manufacturing/industrial production sectors as well as services. The rally in the Yen, however, was largely down to the news of expected rate cuts by the FED in 2024. Inflation figures this week will give markets early indications of the likelihood of a move to a positive benchmark rate in 2024 by the BoJ.
After a tough 2023, the Australian Dollar has nearly bounced all the way back. AUD is now trading above 0.67, representing a monthly appreciation of over 4% against USD and is now down just 1.3% year to date. That being said, we did see more weakness in manufacturing and services PMIs last week with an uptick in unemployment to 3.9%. The RBA meeting minutes release, this coming Tuesday, will give markets a good idea of the potential path of interest rates moving forward. Can the Aussie hold its momentum?
SOUTH ASIA
INR strengthened by 0.5% to end the week trading at 83.0 vs USD. The Rupee was supported by a weaker dollar and a wave of strong data releases in manufacturing, industrial production and exports. Inflation remains sticky at 5.5%, leaving the door open to potential rate rises from the RBI if necessary. All in all, the Indian economy continues to power ahead despite a relatively bleak global picture.
PKR ended the week 0.2% stronger against USD a touch above 283. The Central Bank opted to hold rates at 22%, the weakness in USD largely offset any potential negative moves in PKR from this. Consumer confidence showed a welcome increase as we await news on the timing for the next tranche of the IMF loan to be dispersed.
MIDDLE EAST AND AFRICA
The Nigerian Naira remains highly volatile, and the parallel market continues to diverge from the official market rate due to dollar shortages. The parallel market depreciated by a further 2.75% in the last week. The weakening Naira is also putting more pressure on prices as imports become more expensive. Food inflation alone is now at 32.8% year on year, with overall inflation sitting at 28.2%. Friday’s figures for both these measures of price pressure came in above expectations as the central bank continues to try and address dollar availability. The CBN is expected to raise rates by 25 basis points this week to 19%. This, however, is highly unlikely to provide relief for the struggling currency. More aggressive moves in rates would be needed to stabilise matters.
Kenyan Shilling was little changed last week, despite a declining US Dollar. There have been reports of potential dollar inflows to help arrest the slide of the Shilling, but nothing so far has materialised. There were no data releases of note out of Kenya last week.
South African Rand ended the week trading a touch below 3% stronger against USD at 18.3. There were mixed data releases last week, with mining, gold production and core inflation all coming in above expectations. Misses in manufacturing and building permits were cancelled out by the weakening dollar. Overall, a strong week for the Rand as we head into the holiday period.
EUROPE
GBP had another strong performance last week against USD, with a rise of over 1% to end the week trading at 1.27. Data releases were mixed out of the UK last week. The major market mover was the ‘hawkish pause’ from the BoE on Thursday. The BoE does not do press conferences like those of the FED, so markets focus on the vote split of MPC members. There were no votes for a cut in this meeting, with 3 voting to hike above 5.25%. The BoE clearly believes they have more work to do in the fight against inflation as price pressures persist. This divergence from the FEDs dovish rhetoric caused sterling to appreciate back to levels last seen in early September. Forecasts for rate cuts were also pushed back to later dates as sterling looks set to benefit from sticky inflation in the UK. Inflation figures released on Wednesday are set to show headline inflation above 4% with the core reading still well above 5%, far higher than in the US.
The Euro jumped back above 1.09 against the Dollar last week. Data misses in the industrial and manufacturing sector were offset by a jump in wage growth to 5.3%. The ECB on Thursday opted to hold rates at 4.5% and struck a more hawkish tone than their American counterparts. While growth and economic activity remain stunted, persistent price pressures are set to support the common currency in the near term. Expectations of rate cuts were rolled back following Lagarde’s hawkish press conference. The inflation data release this Tuesday will give markets a clearer picture on the potential path for rate cuts from the ECB as we move into the new year.
OTHER NEWS
Russia’s central bank raised its key interest rate by 100 basis points to 16%, its fifth consecutive rate hike. The Ruble now trades at below 90 against the dollar having traded above 102 in October.
PERFORMANCES AGAINST US DOLLAR
Information as of 18th December 2023 10.00 UAE time.
