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USD upside potential remains compelling for now
FX View:
In this our last FX Weekly of 2024 we would like to wish our readers a very happy festive holiday and best wishes for a wonderful 2025!
The final event-packed week of the year is coming to an end with the US dollar stronger after a hawkish communication from the FOMC and Fed Chair Powell fuelled a large jump in front-end yields. Barely one-and-a-half 25bp rate cuts are now priced through all of next year. This may ultimately prove too conservative we believe but for now will help support the dollar. ECB signals on more rate cuts over the coming meetings, a BoE decision this week that saw more votes for a cut than expected and a BoJ dovish communication will all add to the FX divergence trade. Year-end positioning risks aside, we see increased risks of EUR/USD testing parity in Q1 and the potential need for the MoF in Japan turning to intervention to halt the renewed slide of the yen. All of this and Trump is likely to act quickly, announcing trade tariff policies on inauguration day or very soon after.
BROAD-BASED USD STRENGTH IN LAST FULL TRADING WEEK OF THE YEAR
Source: Bloomberg, 14:00 GMT, 20th December 2024 (Weekly % Change vs. USD)
Trade Ideas:
We have cut our long USD/CAD trade idea. Our P&L total in 2024 amounted to a profit of $220,639, the fourth calendar profit in the five years we have incorporated trade ideas in our FX Weekly.
JPY Flows: Balance of Payments:
The October data revealed no surprises in the current account data but the bond flow data by destination country revealed Japanese investors were heavy sellers of bonds in the euro-zone. France, Germany, Spain and Italy combined saw Japanese record bond selling in October.
Sentiment Analysis on the latest FOMC Press Conference (including Q&A):
This week, the FOMC delivered a hawkish update, lowering its key policy rate by 25bps and tempering expectations for future cuts. Sentiment remains high but has dipped recently due to fewer positive references to 'Inflation,' the 'Labour’ market, and the 'Economy.'
FX Views
USD: FOMC will help the US dollar in Q1
The financial markets were anticipating a cut from the Fed that was coupled with increased caution over the outlook ahead but the communications from the FOMC on Wednesday evening were certainly much more hawkish than we or the markets expected. The primary guidance tool was the most obvious example of this with the market expecting a reduction of one rate cut in the median dots for 2025. Instead we got a reduction of planned rate cuts from four published in the Summary of Economic Projections in September to two. The SEPs still then imply 50bps of additional cuts in 2026 and one in 2027 taking the federal funds rate to 3.125% - slightly above the latest estimate of the long-run neutral rate – 3.00% (up from 2.875%). The statement now refers to the “extent and timing” of rate cuts going forward with Fed Chair Powell confirming in the press conference that the FOMC had entered a “new phase” that means the FOMC will be “cautious on future rate cuts”. There was a dissent (Fed President Hammack) while Powell acknowledged that the decision to cut was a “close call”. The policy stance is now described as “significantly less restrictive”.
The communications from the FOMC certainly justify posing the question – why did they cut at all? In reality there was limited reasons for cutting. The decision looks to us to have been a lot more political given a decision not to hike, even if it had been telegraphed ahead of the meeting, would have been viewed as the Fed making an assessment of the inflation impact from the expected policies of President-elect Trump. Previously Fed officials have stated they would not second-guess policies and would wait for confirmation before incorporating into policy decisions. But Powell stated this week that “some members” had incorporated Trump’s policies into their SEP projections and some had not, which only confuses the outlook further. But given we have had four 0.3% m/m increases in core CPI and strong consumer spending data, the macro backdrop simply didn’t justify a move from the Fed.
Given we would argue there wasn’t really a clear obvious fundamental justification for cutting rates this week we do understand the logic of the hawkish communications that signal a pause is coming. There has been a dramatic decline in expectations on Fed easing next year and we would argue to an extent that will likely prove excessive. There is now only one-and-a-half 25bp cuts by the end of 2025 and we expect the FOMC will ultimately end up cutting by more than that. However, over the near-term this market pricing could be sustained and even move in the direction of reducing further FOMC rate cuts. A March cut is now a 50% probability but we see risks that incoming economic data could continue to show resilience. There are already signs of a post-election bounce in sentiment. The NFIB Small Business Optimism Index surged in November and SMEs could prompt a pick-up in activity and hiring while consumer confidence could get a lift as well. If economic activity does remain resilient, then the FOMC could be inclined to pause for longer. There is also a tendency for CPI prints to reveal a seasonal upward bias in the first quarter of the year. We admit though that a prolonged government shutdown could impact this possible positive sentiment.
SUMMARY OF ECONOMIC PROJECTIONS – DEC 2024
Source: Federal Reserve; SEPs December 2024
SUPERCORE CPI STILL ABOVE PRE-COVID AVERAGE
Source: Bloomberg, Macrobond & MUFG GMR
If the US economy does prove resilient over the coming months, the theme of US divergence versus the rest of the world will likely persist. This is clear to see versus the euro-zone. The 2-year EZ-US swap spread on Wednesday plunged to a new low of -198bps, surpassing the lows recorded during the post-Ukraine invasion period in 2022 when energy prices in Europe surged. That was when EUR/USD was trading well below the parity level and hence highlights where the risks lie over the coming months. A breach of parity in Q1 remains very plausible. The UK-US swap spread level is less compelling in pointing to GBP/USD declines but yesterday’s BoE meeting indicated a greater willingness to cut the policy rate with a close vote of 6-3 to remain on hold. We covered the BoE announcement yesterday in an FX Focus piece (here).
We could yet see the dollar buying peter out as we enter the quiet Christmas / year-end period of trading. There is certainly an increased risk that you see some lightening of positioning ahead of the close of the year. Our z-score analysis to measure how stretched positioning amongst Leveraged Funds is points to EUR shorts being at the most stretched since just after the GFC in 2010 and during the euro-zone debt crisis in 2012 at close to three standard deviations from a two-year average. The positioning data does not show a clear pattern of positions being lightened into year-end (five of last ten years in Dec) but given the extreme level of EUR shorts it is a potential risk. We also should not completely discount the risk of increased JPY volatility into year-end that could prompt the Japanese authorities to intervene to halt yen depreciation. The bounce in USD/JPY has been significant and we are fast approaching the 160-level where intervention took place in July that marked a turn lower through July and August. Might it not be better for the MoF to consider action now in thinner trading conditions than wait until President-elect Trump takes office?
Notwithstanding year-end risks of some reversal of US dollar strength, we maintain our view of further US dollar strength in Q1 as Trump tariff announcements coincide with an economic backdrop that reinforce a dollar-supportive divergence in monetary policy.
Z-SCORE – LEVERAGED FUNDS’ EUR POSITIONING
Source: Bloomberg, Macrobond & MUFG Research
EZ-US 2YR SWAP SPREAD VERSUS EUR/USD
Source: Bloomberg, Macrobond & MUFG Research
CAD: Weighing up risks to outlook for CAD after recent sharp sell-off
The CAD has continued to weaken against the USD over the past week resulting in USD/CAD hitting a fresh year to date high yesterday of 1.4467. It has underperformed alongside other G10 commodity currencies this month and the JPY. The next key resistance level for USD/CAD is provided by the initial COVID shock high from March 2020 at 1.4668. The pair has now risen by almost 10 big figures since late September which in percentage terms over the last 60 trading days is a greater than two standard deviation move analysing historical price action dating back to the early 1970’s. More extreme price fluctuations have become more common for USD/CAD since the Global Financial Crisis.
The latest sharp weakening of the CAD has been driven by both building expectations that the unusually wide policy divergence between the BoC and Fed will persist, and by trade policy uncertainty triggered by President-elect Trump’s threat to impose a 25% tariff on all goods imports from Canada (click here) if they don’t take action to tighten border controls and restrict the flow of illegal immigrants and rugs into the US. Canada’s highly indebted economy has proven more sensitive to higher rates than US economy in the current economic cycle resulting in more slack opening up in the Canadian economy. The BoC has already cut rates by 175bps since June taking the policy rate to the top of their estimate of the neural policy range between 2.25% and 3.25%. At their last policy meeting the BoC signalled that they would now slow the pace of easing after delivering back-to-back 50bps rate cuts in October and December. We expect at least two more 25bps cuts in 1H 2025.
In contrast, the Fed has only lowered rates by 100bps since September and just delivered a hawkish policy update revealing plans for only two further 25bps cuts next year. We expect the Fed to pause rates in January and there is an increasing likelihood of a more extended pause if Trump’s initial policy focus lifts inflation risks at the start of next year. The BoC and Fed are both likely to face tighter labour supply conditions in the coming years as both Canada and US tighten immigration. The Canadian government plans to allow significantly lower new permanent residents to 395k in 2025 down from this year’s pan of 500k and to lower temporary residents by around 30k to 300k. As a result, the government expects the population to decline marginally by -0.2% in 2025. Slower labour force growth will argue for more caution in continuing to cut rates next year. The main downside risk that could still trigger deeper BoC cuts would be if higher tariffs are imposed on Canada but that is not our base case scenario. We are currently assuming that Canada will tighten border controls sufficiently to prevent tariffs being implemented but trade policy uncertainty will continue to linger ahead of the scheduled review of the USMCA trade deal on 1st July 2026.
USD/CAD HAS MOVED SHARPLY HIGHER
Source: Bloomberg, Macrobond & MUFG GMR
WIDE US-CA YIELD SPREADS EXPECTED TO PERSIST
Source: Bloomberg, Macrobond & MUFG GMR
Trump’s tariff threat has already indirectly undermined political instability in Canada over the past week when former Finance Minister Chrystia Freeland resigned just hours ahead of presenting the fall economic statement. Former Finance Minister Freeland’s decision to resign was driven by a falling out with Prime Minister Trudeau over the direction of fiscal policy. Freeland stressed that the government should keep “our fiscal powder dry today, so we have the reserves we may need for a coming tariff war. That means eschewing costly political gimmicks, which we can ill afford and which make Canadians doubt that we recognize the gravity of the moment”. According to the fall economic update, the government is on course to record a deficit of CAD48.3 billion in current fiscal year 2024-25 coming at around 1.6% of GDP compared to the finance department’s forecasted deficit of CAD42.2 billion. While wider than planned, the budget deficit is still relatively small compared to other major economies. The fall economic update also outlined key new expenditures including a CAD1.3 billion for border agencies over six years that will help to meet President-elect Trump’s demands for tighter order border controls in order to avoid tariffs.
Recent political developments have further undermined confidence in Prime Minister Trudeau and the minority Liberal government. It has heightened speculation over the possibility of an early election in Canada. The next election is currently scheduled to take place on or before 20th October under the fixed-date provisions of the Canada Elections Act. With the Liberals currently trailing well behind the main opposition party of the Conservatives in the polls, it is highly unlikely that they would choose to hold a snap election. A vote of no confidence in the government would be needed to trigger a snap election. The Conservative party would need the support of both the New democratic Party (NDP) and the Bloc Quebecois. The Conservatives currently hold 119 seats, the NDP 25 seats and Bloc Quebecois 32 seats which are needed for majority of at least 170 seats. NDP leader Jagmeet Singh has expressed mixed signals regarding a vote of no confidence. While he has criticized Trudeau and called for his resignation, he has not committed to supporting a vote of no confidence in the government. Back in September, the NDP pulled out of a “supply and confidence” arrangement with the Liberals. Similarly, Bloc Quebecois Yves—Francois Blanchet has been reluctant to back a vote of no confidence.
The Conservative party appear well placed to win a majority in parliament next year when elections are held. They currently hold lead or around 18-20 percentage points over the Liberals. The Conservative party are viewed as more business friendly and plan to abolish national insurance for self-employed and cut it for employed which could be favourable for growth in Canada and support the CAD. However, they could adopt a more confrontational approach when negotiating with Donald Trump posing downside risks for CAD. They have argued that a strong, united response is necessary to protect Canada’s interests. Our forecasts for CAD in 2025 rest on the assumption that Canada avoids trade tariffs. If we are wrong, CAD can still weaken significantly. We have only closed our long USD/CAD trade idea to take profit ahead of the Christmas holiday period when fundamentals could be less important for driving FX.
LATEST POLITICAL OPINION POLLS FROM CANADA
Source: Polling firms listed above
Weekly Calendar
|
Ccy |
Date |
BST |
Indicator/Event |
Period |
Consensus |
Previous |
Mkt Moving |
|
GBP |
12/23/2024 |
07:00 |
Current Account Balance |
3Q |
-- |
-28.4b |
!! |
|
NOK |
12/23/2024 |
07:00 |
Unemployment Rate Trend |
Nov |
-- |
4.0% |
!! |
|
GBP |
12/23/2024 |
07:00 |
GDP QoQ |
3Q F |
-- |
0.1% |
!! |
|
CAD |
12/23/2024 |
13:30 |
GDP MoM |
Oct |
-- |
0.1% |
!! |
|
USD |
12/23/2024 |
15:00 |
Conf. Board Consumer Confidence |
Dec |
113.0 |
111.7 |
!! |
|
AUD |
12/24/2024 |
00:30 |
RBA Minutes of Dec. Policy Meeting |
!! |
|||
|
USD |
12/24/2024 |
13:00 |
Building Permits |
Nov F |
-- |
1505k |
!! |
|
USD |
12/24/2024 |
13:30 |
Durable Goods Orders |
Nov P |
-0.3% |
0.3% |
!! |
|
USD |
12/24/2024 |
15:00 |
New Home Sales |
Nov |
663k |
610k |
!! |
|
JPY |
12/24/2024 |
23:50 |
PPI Services YoY |
Nov |
3.0% |
2.9% |
!! |
|
JPY |
12/25/2024 |
06:00 |
Machine Tool Orders YoY |
Nov F |
-- |
3.0% |
!! |
|
JPY |
12/26/2024 |
05:00 |
Annualized Housing Starts |
Nov |
0.778m |
0.779m |
!! |
|
USD |
12/26/2024 |
13:30 |
Initial Jobless Claims |
-- |
-- |
!! |
|
|
JPY |
12/26/2024 |
23:30 |
Jobless Rate |
Nov |
2.5% |
2.5% |
!! |
|
JPY |
12/26/2024 |
23:30 |
Tokyo CPI YoY |
Dec |
2.9% |
2.6% |
!! |
|
JPY |
12/26/2024 |
23:50 |
Retail Sales MoM |
Nov |
0.6% |
-0.2% |
!! |
|
JPY |
12/26/2024 |
23:50 |
Industrial Production MoM |
Nov P |
-3.5% |
2.8% |
!! |
|
CNY |
12/27/2024 |
01:30 |
Industrial Profits YoY |
Nov |
-- |
-10.0% |
!! |
|
CNY |
12/27/2024 |
Tbc |
BoP Current Account Balance |
3Q F |
-- |
$146.9b |
!! |
|
SEK |
12/27/2024 |
07:00 |
Trade Balance |
Nov |
-- |
0.6b |
!! |
|
NOK |
12/27/2024 |
07:00 |
Retail Sales W/Auto Fuel MoM |
Nov |
-- |
0.2% |
!! |
|
USD |
12/27/2024 |
13:30 |
Advance Goods Trade Balance |
Nov |
-$101.1b |
-$98.3b |
!! |
Source: Bloomberg, Macrobond & MUFG GMR
Key Events:
- There are no major economic data releases or events scheduled in the Christmas holiday shortened week.
- The economic data release highlights include: i) the latest GDP reports from Canada and the UK, ii) the minutes from the latest RBA policy meeting from 10th December, iii) the latest labour market and Tokyo CPI reports from Japan and iv) the US trade report for November. We are not expecting the data reports to be significant market movers.
- We have learnt over the past week that the Fed plans to slowdown the pace of easing from next year. The median projection for the Fed funds rate at the end of next year shows a further 50bps of cuts compared to 100bps of cuts forecast back in September.
- The BoJ displayed more caution than expected over the possibility of hiking rates again as soon as January. Governor Ueda indicated that the BoJ would have more info on wage growth in Japan and US policy under the Trump administration by the March policy meeting signaling that they could wait until march to hike rates again rather hiking sooner in January.
- The BoE continues to signal that it remains comfortable to lower rates gradually but expressed some optimism that the UK labour market is now balanced helping to dampen upside inflation risks. We still expect the next BoE rate cut in February.
