USD suffers setback ahead of FOMC meeting

USD: Focus to shift back to Fed update after US Treasury funding announcement

The US dollar has stabilized during the Asian trading session after suffering a brief sell-off in response to the announcement from the US Treasury outlining its borrowing requirements for the current quarter. The US Treasury now estimates that it will require USD760 billion in net borrowing for January-through-March, down from their previous estimate of USD816 billion released back in October. The lower than expected borrowing estimate triggered an adjustment lower in US yields which has weighed on the US dollar. The 10-year US Treasury yield has continued to move lower overnight and currently stands around 4bps lower than prior to last night’s announcement from the US Treasury. It has resulted in the 10-year US Treasury yield moving back below support from the 200-day moving average that comes in at around 4.08%. The US Treasury noted that the borrowing estimate was lowered by USD55 billion largely 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 USD750 billion. It compares to during the October-December 2023 quarter when the US Treasury borrowed USD776 billion and ended with a cash balance of USD769 billion. Normally, the US Treasury’s borrowing announcements do not have a significant lasting impact on US dollar performance. Market attention will now shift back to the Fed’s policy update this week which should prove to be more pivotal for US performance going forward (click here).    

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 the JOLTs job openings figures can be volatile month to month, they have been indicating that labour demand is softening in the US. Furthermore, 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 that are more consistent with the Fed meeting their 2.0% inflation target. We expect the US labour market data to be important in determining whether the Fed begins to lower rates as soon as in 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 as soon as in March in light of the resilience of the US economy to higher rates. It partly supports our outlook for the US dollar to rebound in Q1 (click here).        

EUR HAS CORECTED LOWER IN RECENT WEEKS

Source: Bloomberg, Macrobond & MUFG GMR

EUR: ECB signalling more openness to earlier rate cuts

The US dollar has also benefitted from the dovish repricing of ECB rate cut expectations which has contributed to short-term yield spreads moving back in its favour in recent weeks. The euro-zone rate market has become more confident that the ECB will begin to cut rates sooner this year at the April policy meeting which is now fully priced for the first 25bps rate cut. The earlier expected start to the ECB’s rate  cut cycle has also encouraged market participants to price back in more rate cuts for this year as a whole. There are currently around 143bps 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 16bps 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 who have expressed more openness to cutting rates earlier than in June.  Governing Council member Villeroy de Galhau stated over the weekend that the “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 suggests that ECB members are not fully in agreement with the plans outlined by President Lagarde to deliver the fist 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 as soon as 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 are consistent with our own forecasts for the ECB to begin cutting rates in Q2 and for 125bps 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.           

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
IT	09:00	Italian GDP (QoQ)	Q4	0.0%	0.1%	!
GE	09:00	German GDP (QoQ)	Q4	-0.3%	-0.1%	!!!
EC	09:00	ECB's Lane Speaks	--	--	--	!!
EC	10:00	Business Climate	Jan	--	-0.45	!
EC	10:00	GDP (QoQ)	Q4	-0.1%	-0.1%	!!
US	13:30	Dallas Fed PCE	Dec	--	1.50%	!
US	14:00	S&P/CS HPI Composite - 20 s.a. (MoM)	Nov	--	0.6%	!
US	15:00	JOLTs Job Openings	Dec	8.750M	8.790M	!!!
GE	15:30	German Buba President Nagel Speaks	--	--	--	!!

Source: Bloomberg