USD regains upward momentum alongside pick-up in geopolitical risks

USD/JPY: Geopolitical tensions & Japan inflation in focus

The US dollar has regained upward momentum in recent days resulting in the dollar index hitting a fresh year to date high overnight at 107.21. It takes the dollar index to within touching distance of the 3rd October 2023 high at 107.35. A break above that level would then open the door for the US dollar to extend its advance heading into year end and to move back towards the highs from autumn 2022 between 110.00 and 114.00. Escalating geopolitical tensions between Russia and the West have played a role in boosting demand for the US dollar in recent days alongside the European regional safe haven currency of the Swiss franc. EUR/CHF has fallen back below the 0.9300-level for the first time since the disorderly unwind of carry trades back in early August. It follows reports that Russia used a new medium-range hypersonic ballistic missile on Ukraine yesterday in a move that looks like a warning to the West. Russian President Putin described the strike as a” successful test”. The strike is in response to the decision by the US to allow Ukraine to use ATACMS missiles to hit military targets in Russian territory, and a similar decision by the UK as well. Russia could also be sending a message to President elect Donald Trump who has said he could end the war in 24 hours. Russia is attempting to expand territorial gains in Ukraine ahead of Donald Trump taking power early next year ahead who could then attempt to reach a ceasefire agreement. While geopolitical risks in the region could escalate further heading into year-end, they are then expected to ease next year.

In other developments overnight , the main economic data release was the latest CPI report from Japan for October. The report revealed that core inflation excluding fresh food slowed less than expected to 2.3%Y/Y in October down from 2.4% in September. The so-called core core inflation measure which excludes fresh food and energy increased by 0.2 percentage points to 2.3%. The break down revealed that services secotr inflation picked up as well by 0.2 percentage points to 1.5%. The stronger than expected inflation data for October is another supportive development for the BoJ to continue to raise rates further. There have been mixed policy signals from Governor Ueda this week over the timing of the next rate hike. After failing to provide a clear signal over a rate hike as early as next month in a keynote speech at the start of this week, he performed somewhat of a u-turn yesterday by signalling to market participants that next month was a live policy meeting. By signalling that rates could be raised again as soon as next month, it will help to slow the pace of yen weakness heading into year end but is unlikely on its own to reverse the current upward trend for USD/JPY as the US dollar continues to strengthen more broadly. USD/JPY has found it more difficult to break above the 155.00 over the past week.

USD IS ATTEMPTING TO BREAK HIGHER HEADING INTO YEAR END

Source: Bloomberg, Macrobond & MUFG GMR

EUR: France political risks re-emerging

The movement in EUR/USD in October and November has been largely down the US factors with Trump’s election victory the dominant factor dragging EUR/USD down from around the 1.12000-level. US factors will remain important although there is certainly evidence in the price action across the financial market that the ‘Trump trade’ has run out of steam for now and we have reached a new equilibrium level that to a much greater degree factors in the risks associated with Trump’s policies.

But there is a risk now that EUR could come under downward pressure from EUR specific factors with political uncertainty in France returning to the fore. The OAT/Bund spread is creeping higher again and this week has jumped 6bps to trade at 78bps and back close again to the key 80bp-level. The risks began to emerge last week with parliament rejecting the revenue aspects of the budget in a vote (362 vs 192) which led Michel Barnier to suggest that the budget was probably going to have to be passed under Article 49.3 – which effectively allows for the budget to by-pass parliament. That would inevitably prompt the Left Alliance to table a no-confidence motion in the government that risks seeing the government collapse and force Macron to go through a process of finding another PM and government alliance.

The assumption since the last no-confidence motion (when RN abstained) is the Marine Le Pen and RN would avoid supporting no-confidence motions and hence a degree of political stability would continue. However, comments from RN members suggest this might not be the case. Jordan Bardella has stated that the government is running the risk and a road to a vote of no confidence”. Marine Le Pen on Wednesday stated that measures that hurt household incomes were a red line for her party and if crossed “we will vote for a censure”. It is still unclear how this plays out and Le Pen will want to weigh up the consequences of bringing down the government with the benefits of RN as being seen as the responsible party that leaves her in a stronger position for winning the presidency in 2027. Our view has been that RN would avoid bringing down the government given the real prize in focus is the presidency but the risks have certainly increased that the view could be wrong.

The OAT/Bund spread also widened out due to additional supply with an auction yesterday and a looming sovereign debt rating announcement by S&P next Friday. S&P cut France’s rating to AA- on 31st May.

A no-confidence vote could well take place at the end of the budget debate process scheduled for 12th December but in the meantime the increased risks could see the OAT/Bund spread widen through that key 80bp-level which could well prompt another lurch lower for EUR/USD. French politics is certainly set to take on greater focus in the FX markets.

OAT/BUND SPREAD HAS REMAINED ELEVATED SINCE FRENCH ELECTIONS

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	08:30	ECB President Lagarde Speaks	--	--	--	!!
EC	09:00	Manufacturing PMI	Nov	46.0	46.0	!!
EC	09:00	Services PMI	Nov	51.6	51.6	!!
UK	09:30	Manufacturing PMI	Nov	50.1	49.9	!!!
UK	09:30	Services PMI	Nov	52.3	52.0	!!!
SZ	12:40	SNB Vice Chairman Schlegel Speaks	--	--	--	!
GE	13:00	German Buba President Nagel Speaks	--	--	--	!!
CA	13:30	Retail Sales (MoM)	Sep	0.3%	0.4%	!!
US	14:45	Services PMI	Nov	--	55.0	!!!
US	15:00	Michigan Current Conditions	Nov	64.4	64.9	!
EC	15:45	ECB's Schnabel Speaks	--	--	--	!!
US	23:15	FOMC Member Bowman Speaks	--	--	--	!!

Source: Bloomberg