Yesterday unfolded as a rather uneventful day in the FX market, echoing the sentiments of numerous participants.
The air was charged with anticipation as we collectively awaited the imminent release of pivotal US inflation data scheduled for tomorrow. Positioned as the week’s highlight, this data cast a looming shadow on market dynamics, potentially influencing risk appetite, a phenomenon particularly pronounced in the early stages of the calendar year when market participants seek to establish a positive tone for their profit and loss (P&L) books.
The prevailing market sentiment leaned decisively towards risk aversion, contributing to the strengthening of the US dollar. Intriguingly, this upward trajectory persisted despite a slight dip in US Treasury (UST) bond yields compared to their counterparts in the euro-zone. Concurrently, core yields in the euro-zone experienced an uptick for the day.
As hinted earlier, my analysis suggests that the EUR/USD rate may have overextended during the US dollar sell-off in late 2023. The potential realignment of spot to relative short-term rate levels indicates a possible drift in EUR/USD towards the 1.0700-level. These narrative gains prominence when considering the global market’s inclination towards risk-off, facilitating the gradual recovery of the US dollar. Despite a marginal dip in UST bond yields, global equity markets surged significantly last year, with the S&P 500 recording an impressive 24% gain. This robust performance, concentrated in the final two months of the year, sets the stage for what could be a challenging start to 2024. The associated gains also raise concerns about valuation metrics, hinting at potential hurdles for further upward momentum.
Aligned with this perspective, yesterday’s release of the ‘Global Economic Prospects’ report by the World Bank supports the notion of a gloomy global growth backdrop. According to their 2024 forecast, the anticipated 5-year growth run is expected to be the most dismal since the early 1990s. Indermit Gill, Chief Economist at the World Bank, emphasized the necessity for a “major course correction” to avoid squandering opportunities in the 2020s. The forecast predicts a deceleration in global GDP from 2.6% in 2023 to 2.4% this year, with the projected 2020-24 average growth rate of 2.2%, the weakest since 1990-94—a period marked by a US recession, the Gulf War, currency crises, recessions in Europe, and the Mexican peso crisis.
The current subdued trading atmosphere, contributing to the gradual reversion of US dollar selling witnessed last year, remains subject to change. The potential catalyst for shifts lies in the imminent release of the latest Consumer Price Index (CPI) data from the US. Any significant divergence from consensus—whether stronger or weaker—holds the promise of injecting volatility into the markets. With market expectations pricing in a 60% likelihood of a rate cut in March, there is ample room for rates to move in either direction. However, my analysis, which highlights an overshoot of EUR/USD spot relative to rates spread, leans towards a higher likelihood of US dollar strength in response to robust data, as opposed to weakness stemming from disappointing economic indicators.
