USD gives back some of strong post-US election gains

EUR/USD: US election reinforces outlook for wider ECB & Fed divergence

The US dollar has continued to trade at higher levels following the US election although it has given back some of its initial strong gains overnight. The worst performing G10 currencies since the US election have been the euro (-1.6% vs. USD), yen (-1.5%) ad Swiss franc (-1.4%). In contrast, the commodity-related currencies of Australian dollar (-0.2% vs. USD), New Zealand dollar (-0.3%), and CAD (-0.5%) have all held up better. There has been even more mixed performance amongst emerging market currencies. The worst performing currencies have been the Thai baht (-1.9% vs. USD) and the Central European currencies of the Czech koruna (-1.7%), Hungarian forint (-1.6%), and Polish zloty (-1.6%) while the BRL (+1.2% vs. USD) and TRY (+0.2%) have outperformed  The initial price action highlights that Trump’s election victory and likely Red Sweep are viewed as different types of macro shocks for the US and European economies. For the US economy, the looming prospect of significant tariff hikes and continued loose fiscal policy stance is judged as more of an inflationary shock for the US economy that will curtail the Fed’s ability to keep lowering rates in the coming years. In contrast, the European economy is expected to face more of a negative growth shock from the potential implementation of higher tariffs on US imports from Europe although weaker domestic currencies and retaliatory tariffs could create inflationary pressures as well in Europe. It has reinforced market expectations for policy divergence between the Fed and other European central banks. Market expectations for greater policy divergence were evident in the performance of local bond markets yesterday. The yields on the 2-year and 10-year US Treasury bonds closed higher by 8bps and 16bps yesterday. In contrast, the 2-year and 10-year German government bond yields fell by 12bps and 2bps respectively. The developments are in line with our view that EUR/USD is likely to fall back into a lower trading range between 1.0000  and 1.0500 in the coming quarters. 

The Fed will provide their latest policy update tonight just after the US election. It is likely too soon to see the Fed change their plans materially in response to the outcome from the US election. We expect the Fed to stick to plans to deliver a smaller 25bps rate cut at today’s FOMC meeting supported by the recent run of stronger US economic data releases. The Fed will be watching closely in the coming months to see if a Trump victory and likely Red Sweep alongside the reduction in political uncertainty will lead to an improvement in animal spirits and encourage a stronger US economy heading into next year. We are currently assuming that the Fed will still stick to plans to deliver another 25bps rate cut in December as well although this is less of a done deal. We expect the Fed to signal more caution next year over continuing to cut rates if Trump starts to implement higher tariffs in the first half of next year.        

In contrast to in the US, there has been a pick-up in political uncertainty in Europe after the German coalition government of the SPD, Greens and FDP was dissolved after Chancellor Scholz dismissed Finance Minister Lindner from the FDP. It follows a disagreement within the coalition over how to close the funding gap in the 2025 budget. It appears likely to result in the FDP exiting the coalition government while the SPD and Greens are expected to carry on for now as a minority government. The breakdown of the coalition government increases the likelihood of a snap election being held early next year most likely in March according to reports. Chancellor Scholtz is planning to submit a vote of confidence in the Bundestag in mid-January which is widely expected to fail. He would then ask President Steinmeier to dissolve parliament which is usually done within a three-week period, after which new elections are to be held 60 days after the Bundestag ahs been dissolved. Based on current polling, the next government is most likely to be coalition between the CDU/CSU and SPD. The additional political uncertainty in Germany will add to current bearish euro sentiment especially if the AfD outperform expectations. The CDU/CSU has already reportedly ruled out forming a coalition with the AfD.     

YIELD SPREADS CONTINUE TO MOVE IN FAVOUR OF STRONGER USD

Source: Bloomberg, Macrobond & MUFG GMR

GBP: BoE to stick to gradual rate cuts after UK Budget

The pound has performed better than the euro following the US election. It has resulted in EUR/GBP falling back towards recent lows at closer to the 0.8300-level. The initial pound sell-off following last week’s UK Budget that lifted EUR/GBP to a high of 0.8448 has completely reversed. We would expect the UK economy to be less negatively impacted than the euro-zone economy by higher US trade tariffs given the UK’s bigger share of services exports which are much less likely to be negatively impacted by trade disruption. Furthermore, the BoE is expected to remain relatively more cautious over delivering additional rate cuts compared to the ECB. While the ECB sped up the pace of easing at their last meeting in October by delivering the first back-to-back 25bps rate cut and leaving the door wide open to another rate cut as soon as in December, the BoE is expected to stick to plans for more gradual easing at today’s MPC meeting.

As we highlighted after last week’s Budget, the government’s plans for more front-loaded government spending were judged by the OBR to boost growth and inflation in the coming years which if the BoE shares the same views today will prevent the BoE from signalling that it is ready to speed up the pace of rate cuts. We have already dropped our previous forecast for the BoE to deliver back-to-back 25bps rate cuts in November and December. We still expect the BoE to deliver a second 25bps rate cut today after the first cut was delivered back in August although it is unlikely to be a unanimous decision. Inflation and wage growth has continued to slow since the last MPC meeting in September providing justification for the BoE to continue gradually lowering rates. Taking recent developments into consideration, we believe there is a higher likelihood now that EUR/GBP continues to fall to fresh year to date lows and back closer to support at the 0.8200-level which hasn’t been broken since just after the Brexit referendum in June 2016.

US IMPORTS OF GOODS BY COUNTRY IN 2023 (USD MILLIONS)

Source: MUFG GMR

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
NO	09:00	Interest Rate Decision	--	4.50%	4.50%	!!
EC	10:00	Retail Sales (MoM)	Sep	0.4%	0.2%	!
UK	12:00	BoE Interest Rate Decision	Nov	4.75%	5.00%	!!!
US	13:30	Initial Jobless Claims	--	223K	216K	!!!
US	13:30	Unit Labor Costs (QoQ)	Q3	1.1%	0.4%	!!
EC	13:30	ECB's Lane Speaks	--	--	--	!!
UK	14:15	BoE Gov Bailey Speaks	--	--	--	!!!
US	15:00	Retail Inventories Ex Auto	Sep	0.1%	0.5%	!!
US	19:00	Fed Interest Rate Decision	--	4.75%	5.00%	!!!
US	19:30	FOMC Press Conference	--	--	--	!!!

Source: Bloomberg