The dollar's fate is a hot topic today, and we're here to unravel the story. The recent sell-off has some analysts questioning its sustainability, but we believe it's time to trust the greenback's recovery.
In the FX world, the dollar's performance is under the microscope. With Japanese bonds rebounding and US Treasuries and equities set for a boost, the USD is poised for a comeback. And let's not forget the Greenland factor: Trump's presence at Davos could ease tensions and provide a much-needed support system for the dollar. EUR/USD might just dip below 1.1700 in this evolving scenario.
But here's where it gets controversial... The sell-off in the dollar yesterday was a complex affair. It seemed to be a mix of JGB volatility and European concerns about reducing Treasury holdings. The ripple effect from Japanese bonds impacted global fixed income, but the FX market's reaction was not so straightforward. Higher bond yields, even when influenced by foreign markets, can weigh on a currency when investors are already worried about a country's fiscal health. And this is where the USD, GBP, and JPY, the worst-performing G10 currencies yesterday, come into focus.
Our take? We don't think it's wise to jump on the USD sell-off bandwagon. Long-dated Japanese bonds have rebounded, reducing one source of USD downside risk for today's European-US session. Interestingly, S&P500 futures are up, while European equities are struggling to keep up.
And this is the part most people miss... The Greenland issue could be a game-changer. Trump's meeting with EU leaders at Davos might just be the de-escalation we need. History suggests that face-to-face interactions with the US president often lead to tension relief. Trump's words before departing for Davos were telling: "We’ll probably be able to work something out."
With no major US data releases today, the market's pricing for a Fed cut remains steady, indicating that the dollar's upside risks are real amidst broader stabilization.
So, what's next for the EUR? A headline about a Danish pension fund exiting US Treasuries sparked concerns about a European exodus, but the actual impact was minimal. Unless bond volatility spikes (which we don't anticipate), EUR/USD is likely to stay below 1.1700, especially given the USD's seasonal strength and the recent hawkish repricing of front-end USD yields.
In Europe, we're cautious about chasing the SEK rally further. EUR/SEK's short-term undervaluation may lead to an upward correction before a medium-term depreciation trend re-emerges.
Moving on to GBP... Sterling's underperformance yesterday was, in our opinion, a reflection of the risks associated with importing bond volatility, especially for a currency that has recently shown sensitivity to back-end yields due to fiscal concerns. With markets calmer this morning, EUR/GBP might face some downward pressure and dip below 0.870.
The UK inflation report for December, released this morning, didn't provide any major surprises. Our UK economist, James Smith, highlights that the BoE's preferred "core services" gauge remained stable at 4.0% for the third month in a row. Headline inflation's slight acceleration to 3.4% was partly due to food price increases, which MPC members are closely monitoring despite being below the BoE's forecast.
In the CEE region... While the calendar is quiet today, the global narrative is keeping things lively. Yesterday, the risk-off environment, triggered by US tariff headlines, impacted CEE rates as expected, with steepening curves across the board. However, EUR rates at the front of the curve moved in the same direction, and the rate differential remained relatively unchanged. The jump in EUR/USD somewhat counteracted the risk-off sentiment, resulting in minimal FX movement.
We maintain a bearish bias for the next few days, primarily due to local factors and expectations of more rate cuts. However, both global and regional stories point to weaker FX in the region. Today, the focus remains on global developments and Davos talks, but we anticipate a defusing of the risk-off mood and market calming, which should provide stability for the region. In the coming days, the spotlight may shift back to regional narratives.
So, there you have it - a comprehensive look at the FX landscape. What are your thoughts on the dollar's recovery? Do you agree with our analysis? We'd love to hear your opinions in the comments!
