DERBYSHIRE UK, Feb 19, 2024, Week 8. Welcome to Monday. Key events to watch include FOMC minutes on Wednesday as traders look for further clues on the inflation and rate outlook. Meanwhile the Canadian dollar continues showing resilience despite global headwinds while the euro holds steady on cautious optimism around gradually easing inflation. The Swiss franc faces downside pressure on increased dovish policy bets. And the Japanese yen looks set for further weakness given fundamentals.
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USD - Cautious Optimism on Inflation Outlook
The US dollar index rebounded this week on optimism that inflation pressures may be easing, though producer prices rose more than expected in January. The Fed kept rates unchanged in January and indicated it may be appropriate to cut rates later this year if inflation moves toward the 2% target. However, stubborn inflation data has dampened hopes for rate cuts in the near term.
On the fiscal side, Q4 GDP grew a better-than-expected 3.3% annualised. However, January retail sales unexpectedly fell 0.8%, the biggest drop in nearly a year. The dip could be temporary given the 353,000 jobs added in January, the most in a year. The unemployment rate held at 3.7%.
Geopolitically, the US continues strengthening ties with Taiwan and other Indo-Pacific partners to counter China's influence. Domestically, President Noboa of Ecuador ratified military agreements with the US this week.
For traders, inflation data remains key. Further evidence that price pressures are moderating could boost rate cut hopes and weigh on the dollar. However, continued sticky inflation could lead to extended tightening and dollar strength.
CAD - Resilient Despite Global Headwinds
The Canadian dollar has shown resilience in recent weeks despite global economic uncertainties. While the currency weakened past 1.35 per USD after higher-than-expected US inflation numbers, it remains near 2023 highs.
Domestically, Canada posted strong January labour data with a net 37,300 jobs added and the unemployment rate falling for the first time since December 2022. This countered growing pessimism about the economic impact of high interest rates. The Bank of Canada appears likely to maintain its benchmark rate at 5% in coming months to combat stubborn inflation around 3.4%.
Meanwhile, recovering oil prices are supporting the loonie. WTI crude rose over 10% year-to-date to $79 per barrel on supply constraints and Middle East tensions. However, the IEA trimmed its 2023 oil demand forecasts on declining Chinese consumption.
Equity markets were mixed, with materials shares rising on higher copper prices while tech names fell. The TSX Index gained 0.8% over the past week and 1.4% since early 2024.
EUR - Cautious Optimism Amid Gradual Inflation Easing
The EUR held steady above $1.075 as investors weighed cautious remarks from ECB officials against unexpectedly weak US retail sales. Inflation continued its downward trajectory, declining to 2.8% in January, the lowest since March 2022. However, President Lagarde emphasised the need for further evidence on wage growth before considering rate cuts. GDP stagnated in Q4 2023 amid high inflation, borrowing costs, and weak demand.
The EU50 hit a 23-year high, with tech shares surging on earnings and policy optimism. Germany's 10Y yield bounced to 2.4% as UK data showed faster growth and wage inflation versus mixed US figures. Key MEP committees ratified the EU's AI Act. France imposed travel bans on violent Israeli settlers and floated a framework to prevent Hezbollah-Israel escalation. The EC targeted Chinese firms accused of aiding Russia and proposed excluding agriculture from 2040 emissions targets.
Pound Stabilises With Cautious Optimism on Inflation and Growth
The pound is stabilising around $1.26 as economic data presents a mixed but moderately positive outlook for the UK economy. January inflation remained steady at 4%, easing concerns of runaway price growth and aligning with the BOE's projections. Meanwhile, stronger-than-expected retail sales growth in January signals the economy may be turning a corner after entering a technical recession in Q4 2023.
The BOE kept rates unchanged at 5.25% at its February meeting but dropped references to further tightening, acknowledging more balanced risks to inflation. Markets are now pricing in rate cuts later this year on expectations inflation will continue moderating towards the 2% target in 2024. Improving economic data and optimism from BOE Governor Bailey have lifted rate cut hopes.
On the political front, opposition to UK participation in the AUKUS security pact could present domestic economic risks depending on the new government's approach. However, the economic implications remain uncertain.
For traders, data shows encouraging signs of inflation peaking while consumption and growth show nascent signs of improvement after the Q4 contraction. An accommodative shift in BOE policy could further support the pound in coming months. However, political tensions over AUKUS and inflation risks still warrant some caution.
SWISS FRANC faces downside pressure as dovish policy bets build
The Swiss franc has weakened to two-month lows against the dollar, falling below 0.88, on growing expectations that the Swiss National Bank could cut interest rates as early as March. January inflation of 1.3% came in well under forecasts and the central target, strengthening the case for policy makers at a time when Switzerland is also phasing out electricity subsidies. The surprise drop in consumer prices, to the lowest since late 2021, has boosted bets that the SNB could start lowering rates in the first half of 2024.
The franc has also been pressured by a rebound in the SNB's forex reserves over the last two months. After declining for two straight years to hit seven-year lows, the rise in reserves signals potential SNB intervention to curb franc strength. The combination of lower inflation and potential SNB action has driven the USDCHF rate up toward 0.90, a level not seen since mid-December.
Looking ahead, forex traders will be focused on Swiss inflation and GDP data along with SNB policy signals.
JPY - Fundamentals Point to Continued Weakness
The Japanese economy unexpectedly contracted 0.1% quarter-over-quarter in Q4 2023, falling into a technical recession for the first time in five years. This weak data comes amid a backdrop of aggressive monetary easing by the Bank of Japan while other major central banks are tightening policy to combat inflation. As a result, the yen recently hit 32-year lows against the dollar near 150.
The weak GDP print reduces the chance of any hawkish shift by the BOJ in the near-term. This divergence between the Fed and BOJ should continue to weigh on the yen. Meanwhile, inflation remains above the BOJ's 2% target at 2.6% in December, limiting room for further stimulus.
On the fiscal side, Japan's ruling coalition retains a solid majority, providing stability. However, geopolitical tensions with North Korea remain an ongoing concern. Efforts are underway to organize a summit between Japanese PM Kishida and North Korean leader Kim Jong Un to ease tensions.
In summary, while the economy faces near-term headwinds, the outlook is for continued yen weakness driven by dovish BOJ policy and Fed tightening. Key events to watch include CPI and unemployment data on 2/26 and 2/29.
AUD - Cautiously Optimistic
The Australian dollar has shown some strength recently, supported by a weaker US dollar and rising commodity prices. However, the domestic economy faces some headwinds. The unemployment rate rose to a two-year high in January, reinforcing expectations that the RBA will cut rates this year. RBA Governor Bullock reiterated that rates could fall before inflation hits 2.5%, but also warned that further hikes remain possible.
On the positive side, inflation continued to moderate in Q4 2023, declining to 4.1%. The lower print supports the case for rate cuts. Additionally, the ASX 200 index rose for a second straight day, tracking gains on Wall Street and lifted by the mining and energy sectors.
Geopolitically, Australia aims to pressure China to lift outstanding trade restrictions on Australian exports. Canberra also welcomed assurances from PNG that it will not compromise democratic values in security ties with China.
The mix of moderating inflation and still-high unemployment points to a gradual easing of monetary policy this year. But commodity price gains and global uncertainty mean the RBA will remain data dependent in charting its next moves.
The Kiwi Facing Headwinds Amid Slowing Growth and Elevated Rates
The New Zealand dollar, known as the Kiwi, has faced downward pressure in recent weeks amid signs that the country's economy is losing steam. GDP contracted 0.3% quarter-over-quarter in Q3 2023, falling short of expectations, with broad-based declines across private consumption, exports, government spending and investment. This has raised concerns that tighter monetary policy is weighing on growth. The RBNZ left rates unchanged at 5.5% in November, but warned that restrictive rates will need to be maintained for some time to bring down stubbornly high inflation.
The weaker growth outlook has put downward pressure on the Kiwi, which has fallen over 10% against the US dollar since the start of 2023. However, the currency pared some of these losses on Friday following a strong session on Wall Street that boosted risk appetite.
Going forward, the Kiwi may face further headwinds if economic data continues to deteriorate. The unemployment rate ticked up to 4% in Q4, the highest level since mid-2021. Underutilization also rose to 10.7%, suggesting labour market slack is increasing. Meanwhile, inflation eased to 4.7% year-over-year in Q4, but the RBNZ is still forecasting rates to peak at 5.7% to ensure price pressures continue moderating towards the 1-3% target range.
Tighter policy and slowing growth present risks of recession, which could weigh further on the Kiwi. However, the currency could find some support from stabilising commodity prices. Oil prices have rebounded over 10% in 2023 on supply constraints, while gold has pulled back from earlier gains.
Overall, the Trading Economics forecast expects the Kiwi to reach 0.64 USD by end-Q1 2024 on global growth worries and elevated rates. In 12 months, it is projected to recover modestly to 0.67 USD if inflation trends lower, allowing an easing of monetary policy.
Gavin Pearson
Retail trader since 2008
Specialises in forex
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Regular contributor to FXStreet.com analysis and education pages
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