Focus Turns to Fed Update Post US Treasury Funding Announcement

The American dollar has steadied during the Asian trading session after a brief drop in response to the US Treasury's announcement outlining its borrowing needs for the current quarter. The US Treasury now projects a need for USD 760 billion in net borrowing for January through March, a decrease from their earlier estimate of USD 816 billion in October. The lower-than-expected borrowing estimate led to a downward adjustment in US yields, putting pressure on the US dollar. The 10-year US Treasury yield has continued to decrease overnight and is currently around 4 basis points lower than before last night's announcement from the US Treasury. This has resulted in the 10-year US Treasury yield moving back below support from the 200-day moving average, sitting at around 4.08%. The US Treasury mentioned that the borrowing estimate was lowered by USD 55 billion, mainly due to projections of higher net fiscal flows and a higher beginning-of-quarter cash balance. The updated borrowing estimate assumes an end-of-March cash balance of USD 750 billion. This compares to the October-December 2023 quarter when the US Treasury borrowed USD 776 billion and ended with a cash balance of USD 769 billion. Typically, the US Treasury's borrowing announcements don't have a significant, lasting impact on the US dollar's performance. Market attention will now shift back to the Fed's policy update this week, which is expected to be more crucial for US performance going forward.

The Fed will receive more information on the health of the US labour market ahead of tomorrow's FOMC meeting when the latest JOLTS report for December is released this afternoon, and the latest Employment Costs Index for Q4 is released tomorrow. While JOLTS job openings figures can be volatile month to month, they have been indicating that labour demand is softening in the US. Moreover, the last JOLTS report for November revealed that the quits rate dropped to its lowest level since September 2020. It provides a further encouraging signal that wage growth is likely to slow further and move back to levels more consistent with the Fed meeting their 2.0% inflation target. We expect the US labour market data to be crucial in determining whether the Fed begins to lower rates as soon as March. Without evidence of further weakness in the US labour market in the coming months, we are not convinced yet that the Fed will cut rates in March, given the resilience of the US economy to higher rates. It partly supports our outlook for the US dollar to rebound in Q1.

EUR: ECB Signals Readiness for Earlier Rate Cuts

The US dollar has also benefited from the dovish repricing of ECB rate cut expectations, contributing to short-term yield spreads moving back in its favour in recent weeks. The euro-zone rate market has gained confidence that the ECB will start cutting rates sooner this year, with the April policy meeting now fully priced for the first 25 basis points rate cut. The earlier expected start to the ECB's rate cut cycle has also prompted market participants to factor in more rate cuts for this year, with around 143 basis points of rate cuts expected by the end of this year. The implied yield on the December 2024 euro-zone three-month interest rate futures contract has fallen by around 16 basis points over the past week.

The main trigger for the dovish repricing of short-term rates in the euro-zone has been the recent shift in communication from ECB policymakers, expressing more openness to cutting rates earlier than in June. Governing Council member Villeroy de Galhau stated over the weekend that "we will cut rates this year," and regarding the exact date, "not one [meeting] is excluded, and everything will be open at our next meetings." The comments suggest that ECB members are not fully in agreement with the plans outlined by President Lagarde to deliver the first rate cut by the summer. He was joined by Bank of Portugal Governor Centeno, who stated that "we don't need to wait until the May wage data to get an idea about the inflation trajectory." He favours moving earlier and in a more gradual fashion when cutting rates. Even the more hawkish Governing Council member Kazimir has described a rate cut in April as a concrete possibility, although June "seems more probable," without wanting to jump to conclusions about the timing of the first cut.

Overall, the comments align with our own forecasts for the ECB to begin cutting rates in Q2 and for 125 basis points of rate cuts by the end of this year. An earlier start to the rate cut cycle in April would increase the risk that the ECB could deliver more cuts by the end of this year than our current forecast. It is one reason why we were reluctant to show the US dollar weakening much further in the 1H of this year, even as we expect the Fed to begin cutting rates as well. The incoming data in the coming months will be important in determining the exact timing of the first ECB cut, starting with the release of the euro-zone CPI report for January at the end of this week.

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

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