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EUR/USD is eyeing the key 1.10 level, but we suspect that any breaks above that level will prove unsustainable as the rates picture remains broadly supportive for the dollar until the US growth picture turns decisively negative. We keep favoring a dollar comeback in the near term. In New Zealand, the RBNZ may deliver a hawkish hold
USD: Excessive Weakness
The dollar has stayed under pressure at the start of this week as markets remained bullish on Treasuries across the curve on the back of growing dovish Federal Reserve expectations. The Fed Funds future curve currently prices in the first rate cut in June 2024. Yesterday, soft US home sales data helped consolidate the dollar’s bearish momentum and now endorses the narrative that higher rates are having a more tangible impact on the economy.
Expect the dollar to remain very sensitive to US data, including today’s Conference Board Consumer Confidence index, which is expected to have mildly declined. We’ll also take a look at the Richmond Fed manufacturing index today. On the Fed side, there are a number of speakers to monitor: Austan Goolsbee, Christopher Waller, Michelle Bowman and Michael Barr. The central bank will almost surely keep rates on hold in December, but the softening in its hawkish stance in November was due to the tightening of financial conditions – and the recent drop in rates significantly increases the chances of pushbacks against rates cut speculations, which can help the dollar rebound.
Month-end flows may get in the mix and delay a dollar recovery, but we remain of the view that it is too early to chase the dollar bear trend. There is still some resilience in US data into year-end that can prop up the high-yielding dollar.
EUR: PEPP Discussions Kick-Off
ECB President Christine Lagarde fuelled expectations that the central bank will reshape its bond reinvestment strategy soon yesterday during her EU Parliament hearing. The current indications by the ECB are that its pandemic emergency purchase program (PEPP) will be in the reinvestment phase until the end of 2024, but there has been growing pressure inside the Governing Council to accelerate quantitative tightening.
Tighter financial conditions are generally positive for a currency, but this specific discussion around PEPP reinvestment could have unwelcome spillover into the euro area peripheral spreads. The Italian BTP-bund 10-year spread is more than 25bp below the 200bp pain threshold, but 2024 carries risks for Italian bonds as EU fiscal rules are reinstated and the economy slows. We currently identify Italian bond spreads as one key risk for the euro next year, even if it is not our base case that they will sustainably widen to concerning levels.
Today, the eurozone calendar is quiet, but there are few ECB speakers to watch. Lagarde will deliver a pre-recorded message, and Pablo Hernández de Cos, Joachim Nagel and Philip Lane are also scheduled to speak. The impact on the euro of ECB members’ remarks has been rather muted and EUR/USD should remain almost solely a function of USD moves and Fed rate expectations. We are not convinced the pair has enough backing on the rates side to trade sustainably above 1.10 and favor instead a correction below 1.0900 in the coming days.
