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G10 FX Outlook 2024 - Global Challenges & Conflicting Forces

Summary | Global Challenges & Conflicting Forces For US dollar   

Limited scope initially for USD depreciation

USD weakness unlikely to materialise in H1 given global backdrop 

• Fears of recession in the US have subsided since the middle of this year but signs continue to emerge suggesting a sharper slowdown in economic growth still lies ahead. The labour market will be key for shaping expectations of recession and a further deceleration in nonfarm payrolls growth is very likely. The unemployment rate will rise, wage growth will slow.
• Inflation is now falling faster than expected. The “Higher for Longer” mantra of the Federal Reserve (& other central banks) won’t last much longer. While we cannot ignore the risks of another global inflation shock, assuming this is avoided, the Fed’s inflation target will be as good as met later in 2024.
• This means the Fed will be cutting rates in 2024. 120bps is priced and this and more should be delivered as inflation eases further & the labour market weakens. A first Fed rate cut by March is possible but Q2 seems more likely, possibly on 1st May.
• This reads as a bearish US dollar scenario. Our bias is skewed that way but only in the second half of the year. It will be difficult for the US dollar to sell-off given the host of global challenges that will likely mean weak global growth, volatile financial markets and elevated geopolitical risks which will provide a conflicting force against US dollar weakness.

Weak growth and a faster drop in inflation & ECB rate cuts to weigh on EUR 

• Inflation has dropped markedly in the euro-zone. Weak economic data and looser labour markets than in the US will see ECB concerns over inflation ease in the coming months. Weak growth in Germany will persist, not helped by the increased fiscal constraints. A turn in the global inventory cycle & lower inflation should see better growth in H2 vs H1 next year.
• The ECB is likely to commence cutting its key policy rate in Q2 2024, around the same time as the Fed. We believe this leaves limited scope for EUR/USD to advance in H1 but market participants may then reduce expectations of the extent of ECB rate cuts versus the Fed as the euro-zone economy improves and German manufacturing picks up moderately. We see the Fed cutting by more than the ECB next year implying a mis-pricing in OIS markets.

JPY to outperform notably as BoJ act  

• We expect the BoJ to end YCC and NIRP at the January meeting. This is partially priced but the tone of the BoJ is likely to fuel expectations of further policy tightening later in 2024. We believe the JPY has the greatest scope to outperform within G10 next year. The global inflation shock is reversing and that has greatest implications for JPY with even a partial reversal of the move in USD/JPY from 115.00 to 150.00 implying considerable scope to outperform.
• After such a big move higher and given the attractive carry, short JPY positioning remains substantial but once expectations of a turn in the trend builds further there is a risk of a more abrupt and even larger move stronger for the yen than we currently forecast.

Sticky inflation in the UK means slower BoE easing but GBP strength to fade 

• If there is one country where investors may not be as enthusiastic about falling inflation it is likely to be the UK. Inflation and wage growth remain higher and that will allow the BoE to stick with the “Higher for Longer” mantra longer than other central banks. However, inflation and wages are still set to fall, albeit just a little slower than elsewhere.
• Hence, any GBP outperformance on yield given the slower timing of rate cuts in the UK is unlikely to last. We see GBP gains versus USD ultimately being less than other G10 currencies, implying underperformance versus non-USD G10 in 2024.
• Politics will be a focus for financial markets in 2024. The exact timing of the UK general election next year remains uncertain. We currently see limited impact on the GBP. Downside risks for the GBP from a Labour win should be lessened from Kier Starmer’s increasing shift to the centre ground and his likely strategy of mimicking the early years of Tony Blair time in office by adopting financial market and business friendly economic policies.

Weak global growth outlook to remain dampener on commodity FX until later in 2024

• Weak global growth and high levels of household debt continue to pose downside risks for AUD, CAD and NZD heading into 2024.
• The BoC and RBNZ have already raised their rates to more restrictive levels than the RBA. It creates more room for earlier and deeper rates cuts next year from the BoC and RBNZ in response to slowing growth and inflation.
• We expect the CAD to underperform alongside the USD undermined in part by weaker US growth. Canada’s economy has already slowed more in response to higher rates than the US.
• In contrast, we expect Norges Bank and Riksbank to be more cautious over delivering earlier and deeper rate cuts reflecting ongoing concerns over the scale of domestic currency weakness. NOK & SEK have been two of the hardest hit currencies by the inflation shock in recent years. With the inflation shock set to ease further in the year ahead, we expect NOK and SEK to recover some lost ground after falling to deeply undervalued levels.