USD moves back closer to year to date highs ahead of FOMC meeting

USD: Sharp fall in Chinese yields contributing to stronger USD ahead of FOMC

The major foreign exchange rates have remained relatively stable during the Asian trading session with the dollar index holding just below the 107.00-level which has been a strong resistance level in recent years. The main development overnight has been the release of the latest monthly activity data from China for November. The activity data proved to be softer than expected on the whole putting a dampener on optimism that stepped up policy stimulus will significantly lift growth in China. The main disappointment was the slump in retail sales growth to an annual rate of 3.0% in November down from 4.8% in October. The slowdown in retail sales growth was partly because early promotion of “singles Day” deals front-loaded spending to October according to the National Bureau of Statistics. Still, the average monthly increase in retail sales in October and November of 0.25% was a step down from the increase of 0.47% in September. On a more positive note, there were some tentative signs of life in the housing market. Housing transactions returned to growth in year-on-year terms in November for the first time since Q1 2023. Overall, the disappointing data flow will keep pressure on domestic policymakers to further step-up policy stimulus to boost domestic demand. Last week’s policy announcement stated clearly that China plans to loosen fiscal and monetary policies to provide more support for growth next year. Yields on Chinese government bonds have continued to fall sharply to fresh lows at the start of this week with the 10-year yield hitting a low of 1.73% overnight. It has fallen by around 30bps so far this month. Market speculation is building that the PBoC could deliver another reserve requirement ratio cut before the end of this year. The ongoing decline in Chinese yields should encourage a further weakening of the renminbi alongside the likely implementation of US tariff hikes on Chinese imports from early next year.       

Unlike Chinese yields, US yields have rebounded so far this month helping to widen the yield spread between the US and China. After hitting a low of 4.13% on 6^th December, the 10-year US Treasury yield has since climbed back up towards recent highs at closer to 4.40%. The pick-up in US yields has happened even as the US rate market has moved to more fully price in another 25bps rate cut from the Fed this week after the release of softer CPI and PPI reports for November. What will be more important for US dollar direction after this week’s FOMC meeting will be the Fed’s update guidance for future rate cuts. Recent comments from Fed officials including Chair Powell have expressed more caution over plans to keep cutting rates setting up market participants over the possibility that the Fed will slowdown and skip a meeting early next year rather than continuing to cut at back-to-back meetings. Please see our latest FX Weekly report for more details (click here).        

YIELDS SPREADS CONTINUE TO MOVE IN FAVOUR OF HIGHER USD/CNY

Source: Bloomberg, Macrobond & MUFG GMR

EUR/GBP: France downgrade & MPC meeting in focus

One of the biggest movers amongst G10 currencies at the end of last week was the pound. After hitting a high of 1.2788 on Thursday, cable fell back sharply to a low of 1.2609 on Friday following the release of the weaker than expected monthly UK GDP data for October. Similarly, EUR/GBP has risen back above the 0.8300-level after hitting a year to date low last week of 0.8225.  The GDP report revealed that monthly GDP contracted for the second consecutive month in October which adds to building evidence revealing that the UK economy is slowing more sharply in the 2H off this year after the stronger recovery in the 1H of this year. Bloomberg’s economic surprise index for the UK economy has fallen deeply into negative territory highlighting that the recent economic data flow from the UK has been disappointing. Nevertheless, the BoE is still expected to remain on hold this week (click here) sticking to its more gradual quarterly pace of rate cuts at the current juncture. Market participants will be watching closely to see if there is any indication that the BoE would be willing to step up the pace of easing at the start of next year. The release of softer UK CPI and labour market reports this week would increase the likelihood of a more dovish message from the BoE.      

EUR/GBP has held above the 0.8300-level even after the announcement late on Friday from Moody’s that it has lowered France’s sovereign credit rating by one-notch to Aa3. It reflected Moody’s view that France’s public finances will be substantially weakened over the coming years due to political fragmentation which is more likely to impede meaningful fiscal consolidation. Moody’s now sees a very low probability that the next government will sustainably reduce the size of the fiscal deficits beyond next year, and sees the risk of durable increase in financing costs which would further weaken debt sustainability. They are wary this could create a negative feedback loop between higher deficits, a higher debt load and higher financing costs, against a backdrop of significant annual borrowing needs. The downgrade brings Moody’s rating into line with the assessments form Fitch and S&P. France’s new Prime Minister Francois Bayrou is set to meet with Marine Le Pen today as he attempts to put together a new government. While political developments in France pose downside risks for the euro, they are not yet sufficient to trigger a significantly weaker euro on their own.  

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:00	Manufacturing PMI	Dec	45.3	45.2	!!
EC	09:00	Services PMI	Dec	49.5	49.5	!!
UK	09:30	Manufacturing PMI	Dec	48.4	48.0	!!!
UK	09:30	Services PMI	Dec	50.9	50.8	!!!
IT	10:00	Italian CPI (YoY)	Nov	1.4%	0.9%	!
EC	10:00	Wages in euro zone (YoY)	Q3	--	4.50%	!!
EC	10:00	Labor Cost Index (YoY)	Q3	4.60%	4.70%	!
GE	11:00	German Buba Monthly Report	--	--	--	!
CA	13:15	Housing Starts	Nov	246.0K	240.8K	!!
US	13:30	NY Empire State Manufacturing Index	Dec	6.40	31.20	!!
US	14:45	S&P Global Composite PMI	Dec	--	54.9	!!
EC	16:30	ECB's Schnabel Speaks	--	--	--	!!
CA	20:45	BoC Gov Macklem Speaks	--	--	--	!!

Source: Bloomberg