Navigating ECB and FOMC Pushbacks, Shifting Fair Values, and USD Strength

EUR/USD has dropped to 1.0800, influenced by the Fed and a cautious market. Today's focus is on the eurozone's January CPI release, expecting a dip to 2.7% YoY in the headline rate and 3.2% YoY in the core rate – the lowest since March 2022.

The ECB faces a tougher time than the Fed due to successful disinflation trends and weak activity data, making it harder to resist early easing expectations. Markets predict a 60% chance of an April rate cut. EUR/USD support is shaky at 1.0790/1.0800, and a break could open the door to 1.0715/25.

Meanwhile, the Riksbank has a key meeting today, the first since November 23. Last time, rates were unexpectedly held at 4.00%, leaving room for a potential hike in early 2024. Although the meeting format changes, it's likely the Riksbank will signal the end of the tightening cycle.

Despite concerns about the krona's performance and the conclusion of Riksbank FX hedging sales, they may resist early easing expectations. The market prices in 15bp of rate cuts in the next three months and 60bp in the next six. If the Riksbank manages expectations well, EUR/SEK should stay close to the end 1Q24 target of 11.30. Our outlook remains positive for the undervalued krona, with a year-end forecast of 10.70.

That been said here is my strategy for the USD for the coming 2 months.

Following the FOMC, the US Dollar Index (DXY) has emerged in a robust position, buoyed by Powell's resistance to March rate cut expectations, a pivotal aspect of the outcome. The Federal Reserve has consistently emphasized the need for more evidence of entrenched disinflation, and Powell's reluctance to pre-commit, especially with two payrolls and CPI releases slated before March, underscores this stance.

Although Powell tempered expectations for a March rate cut, the pricing of rate cuts by the market could further propel the USD upwards. Currently, there is a pricing of -31 basis points in rate cuts for the subsequent May meeting and a substantial -140 basis points through the end of 2024. This exceeds the benchmarks set by previous modest rate cut cycles, particularly for the latter half of 2024, and contrasts with the FOMC's December dot plot projections, reaffirmed by Powell as a reliable indicator of the current FOMC mindset.

Adding to the USD's favourability is the evolving situation in China, where key indices have retraced half of the gains stimulated by Beijing's support commitments. The assumption is that until a comprehensive policy package addressing liquidity, solvency, and restructuring in the property sector is implemented, China's economic rebound will face challenges. This message is reinforced by the limited improvement in China's official January Purchasing Managers' Index (PMIs).

Looking ahead, the DXY is poised to target 104.25, propelled by the combination of Powell's measured approach to rate cuts and the uncertain economic landscape in China, which continues to pose challenges to its recovery.

Insights Inspired by Credit Agricole & MUFG: Credit to Their Analysis for Shaping Some Aspects of This Text

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