USD: Price action is dollar negative
DXY is this morning breaking under 102.16 - the low seen during the flash crash of Monday 5 August. There is no flash crash underway today and instead, the dollar's decline looks to be part of an orderly adjustment cycle as the Fed prepares to cut rates.
Fed communication will be the headline story for this week. It starts today with some introductory remarks from our favourite Fed speaker, Christopher Waller, at 16:15 CET today. Wednesday then sees the release of the FOMC minutes from July - when the Fed switched to re-emphasising its dual mandate of both maximum employment and price stability. Friday then sees the main event of the week, where Chair Jerome Powell speaks on the economic outlook at the Fed's Jackson Hole symposium. In addition, Wednesday sees some provisional annual benchmark revisions to the payrolls report, which could see some downward revisions to job gains made in the year to March 2024.
While some may be arguing that the dollar does not need to sell off much further, since a Fed easing cycle to 3.00/3.25% is already priced, we would suggest caution in that the Fed cycle has not even started yet and any softer US data could mean Fed rates start to get priced at accommodative and not just neutral.
At the same time, dollar price action has been soft. Gains made on the back of last week's robust July retail sales have proved fleeting and today's dollar weakness is not being led by softer US rates. It therefore seems like speculators are looking to explore some broad dollar weakness ahead of what should be the first Fed cut on 18 September.
As mentioned above, the only event on the US calendar today are those remarks from Christopher Waller. Let's see if DXY can press 101.75 today, below which a move to 101.00 beckons.
EUR: Rising tide of dollar bearishness lifts EUR/USD
EUR/USD is now approaching its highest level of the year (1.1054, 3 January). Understandably there has been no major re-assessment of the euro's prospects and this is an entirely dollar-led move. In fact, this week's eurozone PMI releases should still show an economic bloc struggling to grow, with a composite PMI index stuck near 50. However, Tuesday sees the release of eurozone negotiated wages for the second quarter. Should these prove sticky, investors could start to rein in expectations of European Central Bank easing this year. Currently, another 68bp of rate cuts are priced this year - which we think is 18bp too much.
Back to the main story of dollar weakness. The default story here could be that EUR/USD will remain in its 1.05-1.11 range - a range that has dominated for the last 18 months. However, the Fed is just about to start easing and our economists look for weaker US activity data as ever-tighter US real interest rates bite harder. Should EUR/USD start to trade through 1.11, we would not underestimate its ability to follow through given that realised volatility has been so low, for so long.
Elsewhere, we've published our latest thoughts on EUR/CHF. Swiss exporters think a fair level is 0.98. We think it will trade more in the 0.92/095 area as global interest rates converge on low rates in Switzerland - and whilst the market struggles to price the Swiss policy rate below the 0.50% area.
GBP: Dollar weakness, plus M&A activity may be helping
GBP/USD looks set for a retest of the year's high at 1.3045 as broad dollar weakness dominates global FX markets. We had thought that the Bank of England's dovishness could keep sterling gains in check. On that, BoE Governor Andrew Bailey speaks at the Fed's Jackson Hole symposium this Friday.
What we may be underestimating, however, is the demand for sterling coming through merger and acquisition activity. The UK this year is the target region for over $200bn worth of deals. The impact of M&A on FX is a very cloudy one - e.g. to what extent a cross-border deal is funded locally. But we suspect M&A may be one of the reasons why sterling is staying a little stronger than our baseline forecasts.
CEE: The rally is done unless the payers return to rates markets
The second half of the month is usually quieter in the CEE region. This week, Poland and Turkey will take the spotlight. The calendar is empty for today and the first event this week will be the Central Bank of Turkey meeting tomorrow. We expect rates to be unchanged at 50% in line with expectations. There are continued challenges with the disinflation process, given administered prices, tax hikes and sticky services inflation. We think an improvement in monthly inflation trends, inflation expectations, and a more visible slowdown in economic activity may lead to the start of rate cuts from November. On Wednesday and Thursday, we will see monthly data in Poland including industry, wages, retail sales, and PPI. While the labour market is showing signs of easing with wage growth slowly falling, the economy is gradually recovering but there are still headwinds coming from abroad and from consumers.
CEE currencies saw strong gains last week, but we feel our bullish stance is running out of steam and we will need to see more momentum from the rates market for CEE FX to have room to rally further. Even though rates bounced a little off the lows last week, market expectations are still on the strong dovish side compared to our economists' forecasts. We think this is mainly the case in Poland, where we see the most room for interest rate payers in the CEE region. Although we would now prefer to be neutral on the Polish zloty and Czech koruna at current levels for the next few days after a strong rally, the return of rate payers could bring a further boost to these currencies. HUF rates witnessed this on Friday and the rate differential has once again returned to the highest levels since mid-July. This brings us back to the view that EUR/HUF could return to 390 ahead of next week's National Bank of Hungary meeting. However, the Hungarian market is closed today and tomorrow.