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USD: Softer US data & lower oil price fuelling growth concerns
The US dollar faced additional weakening in the recent session, spurred by the disclosure of less favourable US economic data. This depreciation, however, exhibited a more confined impact, primarily targeting the euro and yen, as opposed to a broader spectrum of major currencies. Conversely, a resurgence was noted in the US dollar's standing against G10 commodity currencies, encompassing the Australian dollar, Canadian dollar, New Zealand dollar, and Norwegian krone. This nuanced sell-off of the US dollar is indicative of mounting apprehensions regarding the global growth trajectory.
The pivotal factor contributing to this scenario was the notable decline in oil prices. Brent plummeted to a fresh low of USD 76.60 per barrel, further distancing itself from the late September peak at USD 97.69 per barrel. This descent is exerting a tangible downward influence on market-based gauges of inflation expectations and nominal government bond yields. Consequently, this has created a more favourable external landscape for the yen, a currency historically responsive to lower energy prices, declining yields beyond Japan, and escalating concerns about global economic growth. Should these prevailing developments persist, they are anticipated to fortify the yen. Interestingly, the yen has thus far deviated from this anticipated trajectory, continuing to underperform even amid the US dollar's corrective descent. USD/JPY has maintained relative stability, hovering just above the 150.00-level, notwithstanding a 3% dip in the dollar index from its peak of the previous month.
Resultantly, the yen has registered fresh year-to-date lows against various currencies, including the Australian dollar, euro, Swiss franc, pound, Swedish krona, and New Zealand dollar. The recent downturn in US yields and the amplification of global growth concerns were instigated by discernible softness in US economic data at the commencement of Q4, following an unsustainable growth spurt nearing 5% in Q3. Over the past month, both initial and continuing claims have demonstrated an upward trend after a Q3 decline, albeit maintaining levels that are historically low. The release of a markedly weaker nonfarm payrolls report for October has heightened market participants' sensitivity to additional indications of labour market frailty in the immediate term.
Moreover, the pronounced decline in the NAHB housing market index, a key metric reflecting homebuilder confidence, sends a clear signal that the substantial upswing in mortgage rates since the summer is posing a significant headwind to growth in interest-sensitive sectors of the US economy, particularly the housing market. The NAHB index has witnessed a continuous descent over the past four months, approaching levels reminiscent of the conclusion of the previous year. This unfolding narrative has emboldened the US rate market to fully factor in a 25-basis points Fed rate cut by the second quarter of the upcoming year.
GBP: Pricing in earlier & more BoE rate cuts into next year.
Over the past week, the UK rate market has undergone adjustments, reflecting an anticipation of earlier and more substantial rate cuts from the Bank of England (BoE) in the coming year. The implied yield on the June 2024 SOFR futures contract has decreased by approximately 0.14 points since November 13th, nearly fully pricing in the expectation of the first 25 basis points rate cut from the BoE. Looking at the broader picture, the UK rate market has shifted to pricing in almost 75 basis points of BoE cuts by the end of the next year.
This ongoing dovish repricing of the BoE's policy outlook has been primarily driven by indications of softening inflation pressures observed this week. The most recent Labor market report revealed a slowdown in wage growth, although annual rates remain relatively high. While the substantial decline in the annual rate of headline inflation in October was expected due to lower energy prices, the noteworthy aspect was that core and services measures of inflation fell more than anticipated.
The combination of decelerating inflation and sluggish growth in the UK, marked by economic stagnation in recent quarters, is raising scepticism about the BoE's forward guidance to keep rates unchanged for an "extended period." BoE Chief Economist Huw Pill has suggested that the BoE could begin considering rate cuts by the middle of next year, but market participants are now pricing in earlier cuts, particularly in the first half of the upcoming year.
The release of the latest retail sales report for October today further reinforces the evidence of weak cyclical momentum. Retail sales contracted for the second consecutive month, making it the third decline in the last four months. This report is likely to fuel expectations of earlier BoE rate cuts, even though there are attempts by the BoE to discourage such expectations. MPC member Megan Greene emphasized yesterday that rates may need to stay higher for a more extended period. She remains concerned about the risk of persistently high inflation, especially with wage growth still deemed "incredibly high." Greene is part of the hawkish minority at the BoE, having voted for a rate hike in the last three MPC meetings.
The dovish repricing of BoE policy expectations has had a modest impact on the performance of the pound over the past week. This has led to EUR/GBP reaching a new high of 0.8766 yesterday, moving further above the support level provided by the 200-day moving average at around 0.8685. Meanwhile, Cable (GBP/USD) has struggled to surpass the resistance from the 200-day moving average at approximately 1.2445, even after a brief rise just following the release of the weaker US CPI report for October, which triggered a sharp, broad-based US dollar sell-off earlier in the week.
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