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Australian dollar // New Zealand dollar //Canadian dollar // Norwegian krone // Swedish Krona // Swiss franc // Czech koruna // Hungarian forint //Polish zloty // Romanian leu // Russian rouble // South African rand // Turkish lira // Indian rupee // Indonesian rupiah // Malaysian ringgit // Philippine peso //Singapore dollar // South Korean won // Taiwan dollar // Thai baht // Vietnamese dong // Argentine peso // Brazilian real // Chilean peso // Mexican peso // Crude oil // Saudi riyal // Egyptian pound

Monthly Foreign Exchange Outlook

DEREK HALPENNY
Head of Research, Global Markets EMEA and International Securities

Global Markets Research
Global Markets Division for EMEA
E: derek.halpenny@uk.mufg.jp

LEE HARDMAN
Senior Currency Analyst

Global Markets Research
Global Markets Division for EMEA
E: lee.hardman@uk.mufg.jp

LIN LI
Head of Global Markets Research Asia

Global Markets Research
Global Markets Division for Asia
E: lin_li@hk.mufg.jp

MICHAEL WAN
Senior Currency Analyst

Global Markets Research
Global Markets Division for Asia
E: ｍichael_wan@sg.mufg.jp

EHSAN KHOMAN
Head of Commodities, ESG and Emerging Markets Research – EMEA

DIFC Branch – Dubai
E: ehsan.khoman@ae.mufg.jp

CARLOS PEDROSO
Chief Economist

Banco MUFG Brasil S.A.
E: cpedroso@br.mufg.jp

MAURICIO NAKAHODO
Senior Economist

Banco MUFG Brasil S.A.
E: mnakahodo@br.mufg.jp

_{MUFG Bank, Ltd.
A member of MUFG, a global financial group}

February 2024

KEY EVENTS IN THE MONTH AHEAD

1) FED SIGNALS DATA AHEAD WILL BE KEY

The US dollar has started the year by rebounding after the sharp sell-off in November and December consistent with the turn of year seasonal pattern. That seasonal bias was helped by a degree of push-back by central banks, including the Fed, on the prospect of early rate cuts. The Federal Reserve have signalled a March rate is unlikely but two payroll reports and two CPI reports plus one PCE release mean there will be plenty of key data before that March FOMC meeting. So the NFP on 2^nd February and the CPI and PCE reports on 13^th and 29^th February will be key for front-end rate moves and the US dollar. The upturn in regional banking sector concerns due to commercial real estate risks may mean there will be greater attention given the weekly Fed balance sheet data. The Fed has lifted the interest rate charge for use of the Bank Term Funding Program which will cut out arbitrage usage and hence if the outstanding amount (currently a record USD 168bn) remains elevated it will point to continued strains in the regional banking sector. This issue could prompt increased risk aversion and could be a factor the Fed considers when it next meets on 20^th March. Commercial real estate risks are not just for the US and strains could also emerge in the euro-zone and UK markets as well.

2) MIDDLE EAST GEOPOLITICS IN FOCUS

As global central banks deliberate on the timing of commencing rate cuts, geopolitical events need to be monitored closely. The world awaits the US response to the attack on a US base in Jordan that killed three servicemen and that response could see tensions in the region escalate further. A recent attack on an oil tanker and continued attacks on cargo ships in the Red Sea and repeated US/UK attacks on Houthi rebels in Yemen have resulted in a sharp increase in freight costs and for now a more modest increase in crude oil prices. Freight costs (WCI Composite Container Freight benchmark) jumped 138% in January while Brent crude oil jumped 6%. A further escalation of tensions that saw a larger crude oil price increase could start to undermine rate cutting expectations, resulting in a jump in front-end yields and a broader risk-off move. That would create renewed FX volatility and if severe enough could fuel safe-haven dollar demand.

3) MORE EFFECTIVE AND DETAILED POLICIES ARE EXPECTED

On 22^nd January, China’s premier Li Qiang vowed to take more measures to stabilize the slumping equity market. A possible detailed rescue package is likely to help elevate the investor sentiment. For property market, we anticipate that the recent relaxation on bank loan rules will help reduce liquidity constraints faced by developers. In addition, major cities likely Guangdong and Shanghai eased restrictions for home buying lately. More major cities are expected to follow this easing policy to help stabilize China’s real estate sector.

Forecast rates against the US dollar - End-Q1 to End-Q4 2024

Notes: All FX rates are expressed as units of currency per US dollar bar EUR, GBP, AUD and NZD which are expressed as dollars per unit of currency. Data source spot close; Bloomberg closing rate as of 4:30pm London time, except VND which is local onshore closing rate.

US dollar

MARKET UPDATE

In January the US dollar strengthened against the euro in terms of London closing rates, from 1.1059 to 1.0846. In addition, the dollar strengthened versus the yen, from 140.96 to 146.28. The FOMC at its meeting at the end of January held the fed funds rate at between 5.25% and 5.50%. The FOMC has continued with its policy of reducing its securities holdings with QT ongoing at a pace of USD 95bn worth of UST bonds (USD 60bn) and MBS (USD 35bn) of balance sheet reduction each month, although the pace of QT looks set to be tapered possibly starting over the coming months with a deeper discussion expected at the March FOMC meeting.

OUTLOOK

The US dollar rebounded in January and after the common seasonal pattern of weakening into year-end, the dollar followed the equally common seasonal pattern of rebounding at the start of the new year. There were other fundamental factors to reinforce that rebound. The Federal Reserve through speeches and then at the FOMC meeting at the end of January played down the prospect of any near-term reduction in the key policy rate. The statement after the meeting as expected dropped the bias to tighten further but the FOMC now does “not expect it will be appropriate to reduce the target ranges until it has gained greater confidence that inflation is moving sustainably toward 2%”. The FOMC reiterated it was “highly attentive” to inflation risks but acknowledged that the risks to achieving its employment and inflation goals were “moving into better balance”. Powell added at the meeting that he didn’t think it was “likely that the committee will reach a level of confidence by the time of the March meeting” to cut rates.   

But notwithstanding the outcome of this FOMC meeting, it remains clear that the policy stance is restrictive in the US given the real fed funds is now 2.6% with the potential to rise further as inflation falls. For now the economy remains resilient with the consumer continuing to support GDP growth. Consumer confidence has also been rising given the easing of inflationary pressures, although early signs of labour market weakness may be emerging. The IMF in its revised forecasts in January raised its US GDP forecast for this year from 1.5% to 2.1%. But the economy is likely to decelerate as the tailwinds supporting the economy (consumers’ excess savings and broader fiscal stimulus) fade and tighter monetary policy transmits further through the economy. Regional banks may come back into focus with a sharp sell-off at the end of January on concerns over building commercial real estate loan losses.

We are maintaining our US dollar forecasts and see the broader global conditions as not yet conducive to dollar selling. The Fed caution communicated at the January meeting underlines our view that the Fed’s easing cycle will be more pronounced in H2 and by then the global backdrop will improve modestly with a pick-up in growth in Europe and China helping to push the dollar weaker but within narrow ranges.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

Up until the January FOMC meeting we have had the view that the first cut of the Fed easing cycle would start in March because of the historical cycle timing (Fed on average has cut rates after it finishes hiking by roughly 9 months) but our view was also linked to concerns around how to manage the Fed’s balance-sheet QT process and bank reserve levels. Although chair Powell pushed back explicitly and stated the FOMC does not have a March cut as the base-case, we are not ready to change our call. We need to still see how the jobs and inflation data unfolds between now and the March meeting. In addition, if financial conditions were to have an acute tightening and/or banking stress returns in the weeks ahead, that could keep the March cut in play. The March meeting will likely see the launch of how QT-tapering will be implemented and that might mean a May cut looks more likely now than March. If there is a change in our view, we would only push back our expectations by one meeting and shift the rate path accordingly. The rates market continues to remain sceptical and has more of a tendency to rally to lower rates, irrespective of what the Fed states. 

(George Goncalves)

US CONSUMER CONFIDENCE INDEX

US TREASURY BOND YIELDS

Japanese yen

MARKET UPDATE

In January the yen weakened versus the US dollar in terms of London closing rates from 140.96 to 146.28. In addition, the yen weakened versus the euro, from 155.89 to 158.66. The BoJ at its meeting in January left the YCC framework unchanged with the +100bps range maintained but the upper-end of 1.00% described more as a reference rather than a hard limit. The BoJ has still committed to “large-scale” JGB buying when required but the general sense in the market continues to be that YCC will soon be brought to an end. The key policy rate also remained unchanged at -0.10%.

OUTLOOK

The yen strength in November and December, which was partly fuelled toward year-end by the liquidation of yen short positions, reversed in January with the yen the worst performing G10 currency. A number of factors helped fuel the renewed selling – the rebound in global yields as central banks pushed back on market pricing of Q1 rate cuts, and the earthquake in Japan on New Year’s Day that created some economic uncertainty and thus reinforced the view that the BoJ would be cautious in changing the monetary stance. That fuelled foreign currency buying versus the yen as carry positions were re-established. The  near three-fold increase in the limit for tax free household savings accounts (NISAs) may also have resulted in a pick-up of retail outflows through investment trusts funds (Toushins). Data from Toushins indicate about 30% of investment trusts are invested abroad and increased limits could be resulting in the front-loading by households availing of the larger limits. The government is aiming to entice households to take more risk for greater return with households holding over JPY 2,000trn of assets, 52.5% of which is in cash deposits.

While the communication from the BoJ has remained cautious, market pricing still indicates about a 70% chance of an increase in the policy rate to zero percent. Governor Ueda at the policy meeting in January reiterated the view that progress was being made toward achieving the price stability goal. More information between now and the March and April meetings will be crucial. The ‘shunto’ wage agreements will be partially known but by April we believe enough information will be gathered via the BoJ branch network to make that decision. The latest inflation readings do indicate subsiding inflationary pressures but contracting labour supply, additional fiscal stimulus, and the extreme weak level of the yen will all contribute to a BoJ decision in April to abandon NIRP and probably YCC. The BoJ summary of opinions of its meeting in January clearly reveal an intent to hike rates, we believe in April.

We maintain that the yen will strengthen in 2024 as the drivers of yen depreciation start to reverse – falling global inflation and yields, a rate hike and an end to YCC by the BoJ and a shrinking of the energy trade deficit will all add to yen demand. The carry attractiveness of the yen will be diminished as volatility picks up, encouraging a liquidation of yen short positions.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

The BoJ at its meeting in January provided further evidence of two aspects of its monetary policy management – continued caution in determining whether the inflation target is being met but equally continued confidence that progress is being made. We believe the BoJ is determined to alter its policy stance as it no longer believes NIRP and YCC are consistent with the macro backdrop. In December, the BoJ held one of its workshops on assessing the monetary policy framework and the conclusions suggested the negative consequences of these policies are at least equal to the benefits, if not greater. There was evidence of a “nonlinear” deterioration of JGB market conditions the more above 50% the BoJ’s holdings of JGB were while the benefits for households, corporates and financial institutions from positive rates were also highlighted, which were also highlighted in a speech by Deputy Governor Himino in December. While inflation may be set to subside judging from global disinflation, there remains reason to believe mild deflation in Japan has come to an end and we see JGB yields drifting higher as the BoJ changes policy in April.

FINANCIAL ASSETS HELD BY HOUSEHOLDS

BOJ PURCHASES OF JGBS

Euro

MARKET UPDATE

In January the euro weakened versus the US dollar in terms of London closing rates, moving from 1.1059 to 1.0846. The ECB at its meeting in January left the key policy rate unchanged at 4.00% for the third consecutive meeting, following 450bps of rate hikes through to September last year. The ECB is running down APP securities and will commence PEPP run-off in H2 with an estimated EUR 380bn of securities rolling off the balance sheet from both programs combined in 2024.

OUTLOOK

The depreciation of the euro in part simply reflects the fact that the US dollar sell-off in November and December was excessive and January has simply seen some of this move retrace. That is indeed a very common seasonal pattern – US dollar selling into year-end and then that move reversing. Given this retracement has now taken place the momentum from here is likely to be less clear. The focus of the markets is on the timing of the start of rate cuts – March or May for the Fed and April or June for the ECB. What is clear from the ECB’s first monetary policy meeting of 2024 and the communications from Governing Council members is that there is division over the outlook for monetary policy. Clearly inflation is coming down quite sharply and President Lagarde acknowledged this at the ECB policy meeting press conference by stating short-term inflation expectations had come down “markedly”. Considering the euro-zone suffered far more from the natural gas price shock in 2022, the speed in which inflation has come down is very telling. Natural gas prices surged 9-fold on average in 2022 versus the 2019 average compared to 7-fold in the UK and between 2&3-fold in the US. However, Chief Economist Philip Lane suggested more time was required to ensure lower inflation was sustained, hinting at June as a possible time to have enough information to commence rate cuts.

We believe the ECB is probably being overly cautious and pessimistic about inflation and there remains scope for the ECB to ease by April. Real GDP data for Q4 confirmed growth remained close to zero percent in 2023 and the consequences of weaker growth should be seen in the labour market softening this year. Lagarde mentioned wages as a key factor being monitored and the euro-zone Indeed Wage Tracker does look to have peaked and has started to decelerate. That should be confirmed in broader wage data and would then open up the scope to start easing. Lower inflation, easing financial conditions and a sustained period of no growth could allow for some moderate acceleration in GDP growth in the second half of this year.

Over the year as a whole, the forward market indicates a remarkably synchronised easing by the Fed and the ECB, which if correct would point to limited scope for yield driven big moves in EUR/USD. We remain neutral on EUR/USD in H1 but see A slowing US economy emerging, contrasting somewhat with a modest pick-up in euro-zone growth which will allow for EUR/USD to drift higher in H2, although the move will be curtailed by US political risks

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

The 10-year German bund yield plunged sharply into the end of 2023 and the risk given the scale of that move was always that it would partially retrace in Q1. That’s what happened with the yield jumping 15bps to close at 2.17%. The ECB certainly played a role in that with some attempts to push back on the increased speculation of a rate cut as early as Q1. The explicit mention of June by Lagarde and Lane as being the time when enough information should be available to commence easing helped lift yields but investors still sense a shift in thinking on the outlook for inflation that has left market pricing implying a near 100% probability of an April cut. Assuming our view on inflation proving lower than the ECB expects, which leads to an April rate cut, the upside for longer-term yields looks limited from here. The support for yields will come from supply with an estimated EUR 380bn worth of APP/PEPP securities coming off the ECB balance sheet this year (EUR 300bn of which is sovereign). Based on a deficit to GDP of about 3% in 2024 (EUR 430bn), that equates to over EUR 700bn of net supply this year. Falling inflation will be the key determinant for yields but supply will limit the downside.   

PRELIMINARY ESTIMATED APP REDEMPTIONS

EURO AREA WAGE GROWTH YOY, %

Pound Sterling

MARKET UPDATE

In January the pound weakened modestly against the US dollar in terms of London closing rates from 1.2739 to 1.2718. However, the pound strengthened against the euro, from 0.8631 to 0.8528. The MPC did not meet in January and hence the key policy rate was unchanged at 5.25%, following 14 consecutive rate increases through to August before pausing from September.

OUTLOOK

The pound was the top performing G10 currency in January with support provided by the expectations that the BoE will remain more cautious over commencing monetary easing and will therefore be behind the Fed and the ECB in cutting. We agree with that view but at the same time it is also highly likely that the BoE will reveal quite a shift in its views on inflation at its meeting in February. In November the BoE projected inflation falling to target by Q4 2025. This meeting has now taken place just ahead of publication and the achievement of the inflation target of 2.0% is forecast to be achieved briefly this year before inflation then drifts a little higher again. In three years’ time the BoE forecasts 1.9%. There was a 6-2-1 vote with Haskel and Mann keeping to voting for a hike and Dhingra voting to cut. The bias to tighten was remove from the statement. Two still voting for a hike was a bit more hawkish than expected but other elements were on the dovish side.

There was certainly reason for Governor Bailey to inject a note of caution to any reaction to the dovish elements mentioned above. While headline inflation has fallen sharply, underlying inflation and risks associated with inflation remain uncomfortably high. Services inflation stood at 6.4% in December but more concerning the 3 & 6-month annualised rates picked up to 5.0% and 5.2% respectively. The 3mth average annual wage growth is currently at 6.5% with the one-month growth rate also elevated at 5.0%. These are the sticky components of inflation linked to the labour market which has a bigger supply issue than in Europe or the US. While Bailey inevitably painted a much better picture on the inflation outlook, he was also reluctant to fuel expectations of there being scope for rate cuts over the near-term. There is the added uncertainty of the March budget when Chancellor Hunt is expected to cut income tax ahead of a general election later this year.

The February meeting was important in sustaining the belief that the BoE will prove more reluctant in easing its stance given the greater inflation risks given the higher services inflation and wages. With that view maintained, we see scope for GBP outperformance to persist over the shorter-term that may propel EUR/GBP lower from here. We still believe the BoE, like other central banks has probably over-tightened and the initial reluctance to signal notable easing will likely give way and assuming the Fed and ECB cut in April-May-June time, we see the BoE cutting either in May or June. By then GBP outperformance will likely start to reverse and we then expect both GBP/USD and EUR/GBP to drift higher given our bearish USD view.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

The key driver of longer-term yields is inflation and the sharp reversal of the global inflation shock has been rapid with big declines in 10-year yields. The scale of the decline in November and December always made a reversal early this year more likely and that’s what happened with the 10-year Gilt yield increasing 25bps to close at 3.79%. But we don’t see the positive factors for fixed income changing and expect disinflation to remain evident. As stated above, the BoE has probably over-tightened given the speed of decline in inflation and after a period of caution, the BoE will acknowledge this and commence cutting, in either May or June, although August could be feasible if other central banks start to cut later than expected too. The budget will be announced on 6^th March and while this could encourage caution by the BoE in its communications in February, we suspect the budget won’t be a large enough give-away to move the dial on inflation expectations, or create renewed concerns over Gilt supply. Hence, we expect yields can drift lower this year but assume declines will be modest enough given the scale of the decline already.             

CENTRAL BANK RATE FLUCTUATION

UK-US 10YR YIELD SPREAD

Chinese renminbi

MARKET UPDATE

In January, USD/CNY increased from 7.1000 to 7.1678. The PBOC kept the 1-year MLF stable at 2.50% on 15^th January and held its 1-year and 5-year LPR rates unchanged at 3.45% and 4.20% respectively on 22^nd January. A 50bps cut to the reserve requirement ratio (RRR) was announced, effective on 5^th February.

OUTLOOK

China’s consumption-led economy grew by 5.2%yoy in 2023, slightly higher than its growth target of “around 5%” set by NPC in last March. However last year’s robust consumption contribution to overall GDP growth will likely moderate this year, as the reopening effect dissipates. Recent December data showed that the economy was on expansion, with an accelerating sequential retail sales growth and decelerating sequential growth of industrial production and fixed asset investment. And December was another month with weak property activities. The Chinese economy started the year 2024 with some improvements in January NBS composite PMI (50.9 vs. 50.3 in December) and NBS non-manufacturing PMI (50.7 vs. 50.4 in December). January NBS manufacturing PMI increased marginally to 49.2 from 49.0 in December, still indicating persistent contractions in the manufacturing sector despite a slower pace of contraction. Both manufacturing new orders and new export orders PMI edged up slightly but were still below 50.0.

Capital outflow continued amid worries concerning China’s economic outlook. On 22^nd January, China’s premier Li Qiang called for more effective measures to stabilize China’s slumping capital market. Market doubted a possible rescue package of RMB2 trillion offshore fund and RMB300 billion onshore capital would help elevate market sentiment. China’s benchmark CSI 300 Index slipped 5.4% in January, and it has seen a net sell-off of USD2.5 bn worth of China domestic stocks by foreign institutional investors through Northbound Stock Connect, after a USD1.8 bn sell-off in the prior month. Aiming to stabilize the property market, the PBOC and National Administration of Financial regulation (NAFR) announced that developers are allowed to use their bank loans to be pledged against commercial properties to repay bonds and other loans, which is likely to reduce liquidity constraints by developers. Recently, some local governments followed the central government’s guidance to release first batch whitelist of developers for funding. On 27^th January, many cites including Guangdong and Shanghai eased home purchase restrictions.

Lately, most provinces set either a slower or stable growth target for 2024, reflecting less optimistic view compared with last year. To stimulate sentiment and improve employment conditions, we expect a similar “around 5%” national growth target set at the March NPC meeting. More policies ahead are likely to help stabilize the property and stock markets, which in turn would support our view for USD/CNY to decline to 7.0500 by the end of Q1. 

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

Continued negative CPI inflation pushed the real policy rate higher and kept it elevated. To reduce the real funding cost, we see the need of further policy rate easing in 2024. Having said that, the room for further policy rate cuts is limited. China’s 1-year loan prime rate is at 3.45%, at a similar level as the US LPR when the Federal funds rates was at near zero levels in recent rate cutting cycle. Especially, as market sentiment remains at low level currently, we expect no rate cut from the PBOC in near term to maintain CNY stability. Amid pessimistic sentiment towards China’s economic outlook and expectations of further rate cuts, China’s benchmark 10-year government bond yield fell 13bps to 2.43% in January, hitting the lowest level in 22 years. More than 80% of the additional RMB1 trillion special sovereign bonds (planned on October 2023) are expected to be issued in Q1. Balancing sentiment, demand and supply, and the economic growth trajectory, we see a modest increase of 10-year government bond yield by the end of Q1 and the end of this year.

ON A SEQUENTIAL BASIS, PROPERTY INVESTMENT GROWTH FELL IN DEC

Source: Bloomberg, MUFG GMR

CHINA MANUFACTURING ACTIVITY CONTRACTED FOR 4TH MONTH IN JAN

Source: CEIC, MUFG GMR

For other currencies outlooks, please download the PDF version attached at the top of this page.