The US dollar has maintained stability, trading within a narrow 102.00 to 103.00 range against major currencies.
USD: Weakening PPI Spurs Anticipation of Earlier Fed Rate Cuts
The recent release of a weaker-than-expected producer price inflation (PPI) report has bolstered expectations for accelerated rate cuts by the Federal Reserve. The market now prices in the first rate cut by the March FOMC meeting, with around -21bps of cuts expected by March and a cumulative -166bps by year-end. The December PPI report revealed a -0.1% M/M decrease in producer prices, driven by a -0.9% M/M drop in food prices and a substantial -3.0% M/M decline in used car prices. A positive -0.8% M/M reduction in trade services indicated continued gross margin compression for wholesalers and retailers.
These developments have heightened expectations for the upcoming PCE deflator report on January 26, likely to confirm a trend of slowing inflation. The core PCE deflator has slowed to an annualized rate of 1.9% over the last six months to November, fostering anticipation of the Fed lowering rates to make policy less restrictive as confidence grows in inflation returning to target. While the initial weak PPI report led to a US dollar sell-off, follow-through has been limited due to the prevailing range-trading environment.
Another significant factor affecting the US dollar’s performance is the Taiwan election results. The Democratic Progressive Party won the presidency but lost its legislative majority, necessitating collaboration with opposition parties for legislation passage. Lai Ching-te secured the presidency with 40.05% of the vote. In the legislative election, the KMT won the most seats (52), closely followed by the DPP (51), and the TPP (8). This loss means the DPP no longer commands a majority in the 113-seat parliament. The initial foreign exchange market reaction has been negative for the TWD and mixed for other Asian currencies, with the TWD declining modestly against the US dollar since last week’s end. The KRW has been the biggest underperformer, decreasing by -0.5%, while the THB has strengthened by +0.5%. Market participants are closely monitoring evolving relations between the new administration and the Communist party, with the victory for Lai Ching-te increasing the risk of further deterioration. However, the Communist party in China may welcome the loss of the DPP’s majority. Geopolitical risks in the region are not expected to ease significantly, posing a continued headwind for Asian currencies.
GBP: BoE’s Rate Cut Timing in Focus Amid Strong 2024 Start
The GBP has emerged as the top-performing G10 currency in early 2024, making notable gains. Cable has surged to 1.2827, approaching the high from the previous year, while EUR/GBP has dipped below the 0.8600-level. GBP/JPY has experienced a turnaround, rising from just below the 180.00-level to the 185.00-level, marking a reversal after underperforming in December.
At the beginning of the year, market participants adjusted expectations for potential rate cuts by the Bank of England (BoE) in 2024. The implied yield on June and December 2024 three-month SONIA futures contracts increased by approximately 13bps and 21bps respectively since late last year. Despite these adjustments, the BoE is expected to lag behind the Federal Reserve and the European Central Bank in implementing rate cuts throughout the year. The first 25bps cut from the BoE is not fully priced until the 20th June MPC meeting, while the Fed and ECB have fully priced in their first 25bps rate cuts by their 1st May and 11th April policy meetings, respectively.
Looking ahead, the UK rate market is pricing in roughly 25bps less in cuts compared to the eurozone and the US for the year. This divergence reflects investor concerns about a potentially higher risk of inflation persisting in the UK. Reassuring evidence of slowing inflation and wage growth at the end of the previous year eased these concerns, contributing to GBP’s underperformance in December. The upcoming release of the latest UK CPI (Wednesday) and labor market (Tuesday) reports will be closely scrutinized to assess whether the disinflationary trends observed in December will persist, with inflation currently running well below expectations.Top of Form
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