Cautious Optimism and Policy Pivots
Market Analysis for Week Number 08 2024
DERBYSHIRE UK, Feb 22, 2024, Week 8. Welcome to Thursday. The US Dollar sees cautious optimism as markets balance concerns over stubborn inflation against hopes of an eventual policy pivot. Meanwhile, central banks in Canada, Europe, and Switzerland weigh further rate cuts amid moderating price pressures. In the UK, upbeat data counters recession worries, but the BoE leaves the door open to easing. And down under, steady policy and growth offer support as Australia avoids New Zealand's slowing momentum.
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USD - Cautiously Optimistic Outlook Amid Policy Uncertainty
The US dollar index declined 0.3% over the past 14 days to 103.7. This comes as the latest Federal Reserve meeting minutes showed policymakers expressing caution about prematurely cutting interest rates despite market expectations for easing. Concerns follow hotter than expected inflation and jobs data released after the January meeting. With inflation still stubbornly high, the Fed is likely to maintain its hawkish stance in the near term.
Going forward, the dollar may strengthen if incoming economic data continues pointing to persistent inflationary pressures. This could force the Fed to keep rates higher for longer. However, if there are more signs of slowing inflation alongside cooling economic growth, expectations for Fed rate cuts could build, weighing on the dollar. Overall the currency faces policy uncertainty in coming months with both upside and downside risks. Any decisive shifts in Fed guidance could lead to significant dollar volatility.
CAD - Cautiously Optimistic
The Canadian dollar has weakened past 1.35 per USD in recent days, approaching a two-month low. This is largely due to a sharp decline in Canada's inflation rate to 2.9% in January, down from 3.4% in December and below expectations of 3.3%. The lower inflation has increased hopes that the Bank of Canada may cut interest rates in coming months to support economic growth. Additionally, broad-based weakness in the US dollar has contributed to CAD depreciation.
Going forward, the CAD may strengthen if the Bank of Canada signals a rate cut is on the horizon. This could boost economic activity and lead to CAD appreciation. However, risks remain from high household debt levels and a cooling housing market. The CAD will likely trade in a range close to current levels absent a significant shift in BoC policy or economic data. Factors like oil prices and equity market performance may also impact the loonie.
EUR - Steady Outlook Amid Slowing Contraction and Policy Speculation
The euro has consolidated near a one-year high against the dollar, gaining 0.32% over the past 14 days. Sentiment has improved as investors temper expectations for ECB rate cuts following data showing a slower pace of Eurozone business contraction in February. Service sector stabilisation offset further manufacturing declines, leading markets to price in fewer than four 25bps cuts through end-2024 compared to seven previously. The shift indicates the ECB may delay policy easing despite recession worries.
Going forward, the euro will likely hold recent gains barring a sharp growth downturn. Markets expect steady policy in the near-term as inflation remains above target. However, weak demand and easing price pressures may force easing later this year. The currency could strengthen if data improves or geopolitical tensions like the Red Sea blockade intensify. But additional deterioration may accelerate bets on rate cuts, weighing on the euro.
GBP - Steady Amid Cautious Optimism
The British Pound has remained relatively steady over the past 14 days, trading between $1.26 and $1.27. This stability comes despite somewhat dovish remarks from Bank of England policymakers, which opened the door to potential interest rate cuts this year. However, more upbeat economic data has offered a counterweight, including a strong rebound in January retail sales and lower-than-expected inflation. Investors seem cautiously optimistic on the Pound in light of these mixed signals.
In the weeks and months ahead, the Pound may face downward pressure if the Bank of England follows through on rate cuts to support the economy. However, if recent positive data marks the beginning of a broader recovery from the UK's recession, the Pound would likely strengthen. Much depends on whether the economy can maintain momentum after its better-than-expected start to 2024. With cautious optimism the dominant sentiment for now, stability around current levels seems the most likely scenario absent significant surprises on either the hawkish or dovish side.
SWISS FRANC - Currency Outlook Dampened by Diverging Monetary Policy and Falling Inflation
The Swiss franc has hovered near 0.88 per USD over the past two weeks, remaining close to the three-month low of 0.89 touched in mid-February. This weakness reflects contrasting economic conditions and policy outlooks in Switzerland and the United States.
Swiss headline inflation fell to 1.3% in January, dropping below the Swiss National Bank's 2% target for the seventh straight month. This has increased expectations that the central bank could start cutting interest rates as early as March to further stimulate the economy. These rate cut bets have weighed on the franc. Meanwhile, the SNB has also boosted its foreign currency reserves over the past two months, pointing to reduced intervention to weaken the franc after two years of drawdowns eroded reserve levels.
Going forward over the coming months, divergence between Swiss and US monetary policy is likely to keep downward pressure on the franc. The SNB is expected to reduce rates to combat low inflation and counter economic weakness, while the Fed is seen continuing its tightening cycle to curb high inflation. This policy split should maintain the franc's weakness. However, if Swiss inflation proves stickier than expected or the economy shows greater resilience, some pairing of rate cut bets could offer the franc some respite.
JPY - Cautiously Optimistic Outlook Amid Economic Headwinds and Policy Uncertainty
The Japanese yen has hovered around 150 per dollar over the past two weeks, weakening from levels below 150 as Japan entered a technical recession and lost its spot as the world's third largest economy. This bolstered expectations that the Bank of Japan will maintain its ultra-loose monetary policy while other major central banks tighten, weighing on the yen. However, authorities remain vigilant about sharp falls, with the finance minister and vice finance minister warning of potential intervention.
Going forward, the yen will likely remain sensitive to monetary policy divergence between the Bank of Japan and other major central banks. However, there is uncertainty around the timing of potential Bank of Japan policy normalisation. Domestically, the economy faces headwinds from the technical recession, but leading indicators like the stock market and manufacturing PMIs point to cautious optimism. Geopolitically, Japan aims to play a leading diplomatic role in Asia. If global growth stabilises and inflation continues moderating, the yen could strengthen modestly, though sharp swings in either direction remain a key risk.
AUSTRALIAN DOLLAR - Steady Amid Moderate Inflation and Economic Growth
The Australian dollar has appreciated over the past two weeks, climbing towards three-week highs against the US dollar. This is mainly attributed to general US dollar weakness amid uncertainty about the outlook for Federal Reserve policy. Domestically, moderating inflation and signs of economic growth are supporting the currency. The latest RBA minutes show policymakers debated further rate hikes but decided to hold steady for now to assess inflation trends. Data also revealed a pickup in private sector activity and higher than expected wage growth.
Going forward, the Australian dollar could see continued support if inflation continues slowing towards the RBA's target range and the economy sustains moderate growth. However, any indications of persistently high inflation or economic weakness could lead to RBA rate cuts later this year, weighing on the currency. Additionally, shifts in Fed policy and the broad US dollar trend will remain a key external driver of Aussie dollar moves over the coming months.
NZD - Currency Faces Headwinds From Slowing Growth and Rising Rates
The New Zealand dollar has weakened over the past 14 days due to slowing economic growth and expectations of further interest rate hikes. New Zealand's economy contracted 0.3% in Q3 2023, falling short of expectations. This, along with a rising unemployment rate of 4.0%, indicates slowing momentum. At the same time, the RBNZ is projected to raise rates further to 5.7% to combat elevated inflation of 4.7%. These twin headwinds of slowing growth and tight monetary policy have placed downward pressure on the NZD.
Going forward, the NZD may remain under pressure if economic weakness persists and the RBNZ maintains its hawkish stance. However, some support could emerge if inflation continues moderating, allowing the central bank to ease policy later this year. Additionally, the NZD could find buyers if geopolitical tensions between the new government and Labour opposition over AUKUS dissipate. Still, risks remain tilted to the downside for the currency without a significant improvement in domestic conditions.
Gavin Pearson
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Specialises in forex
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