The ‘Fed put’, Soft Landing and the USD

Fed's 'Put,' Eurozone Optimism, and JPY's Resilience

The 'Fed put' unexpectedly surfaced during the December FOMC meeting, as Fed Chair Jerome Powell hinted at potential aggressive rate cuts for 2024. This dovish shift elevated global hopes for a soft landing, boosting market sentiment. While short-term optimism prevails, the long-term market trajectory hinges on economic data quality and inflation persistence.

In December's FOMC meeting, Fed Chair Jerome Powell signalled potential aggressive rate cuts in 2024, creating the 'Fed put.' This shift to a dovish stance buoyed global optimism for a soft landing and improved market sentiment. While short-term impact is positive, the market's long-term direction relies on economic data quality and inflation trends.

Concerns arise over rates markets possibly overestimating rate cuts, risking disappointment if the Fed deviates from dovish expectations. The USD might face challenges against currencies with normalizing central banks like the JPY and AUD, while potentially strengthening against the EUR and GBP if rates markets remain dovish on the ECB and BoE.

The focus is on US Consumer Confidence (Dec) and GDP, with expectations of growth momentum but below historical standards. FX investors are keen on signs of divergence between prices paid and a soft labour component. Despite data importance, FX direction impact may be limited, with attention shifting to next week's core PCE data and Fed communications.

The USD's vulnerability may persist if risk sentiment continues to recover, though existing Fed-related negatives are likely priced in. This could restrain USD downside risks from current levels.

EUR
Divergent communications from the ECB and the Fed caused a decline in EUR/USD to 1.10. The new FOMC dot plot projects three rate cuts next year, while ECB President Christine Lagarde rules out rate cuts, reflecting distinct economic paths. The US faces a slowdown, while the Eurozone anticipates a rebound, aiming for 0.3-0.4% QoQ growth by Q224.

Despite optimistic prospects, the ECB delayed expectations due to uninspiring soft and hard data, reinforced by the cautious December ZEW survey. Lower rates/yields and energy prices' potential benefits may be offset by 2024 fiscal uncertainties. The ECB expects government spending to drive Eurozone growth next year.

Awaited Eurozone flash PMIs may impact optimism, with the composite index expected to contract for a seventh consecutive month. Buba's economic forecasts and ECB speakers may provide insights, while Eurostat's Unit Labour Costs data will be crucial for inflation forecasts.

JPY
JPY experienced volatility, with minimal shifts in short-term fair values against the EUR and USD according to our FAST FX model. Despite a dovish FOMC pivot and a decline in US-Japan rates, USD/JPY's fair value slightly increased due to global equities' rise, stabilized oil prices, a stronger Nikkei, and a higher US-Japan box yield spread.

EUR/JPY's fair value rose, influenced by the ECB's resistance to aggressive rate cuts, despite a decline in the Eurozone-Japan rates differential. Positive factors like Nikkei increases and a decline in peripheral EGB spreads to Bunds elevated EUR/JPY's fair value. Market shifts and BoJ pricing also impacted JPY this week, with investors expecting a status quo at next week's BoJ meeting and throughout 2024.

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