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Bannockburn Global Forex Drivers for the Month Ahead Monthly FX Update January 28, 2024 View Online February 2024 The coming weeks will likely continue the correction of the trends that began last month. The markets recognize that tightening cycle is over. However, they swung hard, pricing in aggressive easing by most of the G10 central banks, including the Federal Reserve and the European Central Bank. Official comments and some high-frequency economic data have encouraged participants to rein in their expectations, reducing the odds of a rate cuts in Q1 and paring back the extent of the cuts this year. The pendulum of market expectations reached an extreme. In the first part of January, pricing of the Fed funds futures strip implied a rate cut at each of the remaining seven FOMC meetings. While this is possible, it is not the most likely scenario, especially given what we know about the national labor market and in the context of still elevated price pressures and above trend growth in Q4 23. Similarly, at the extreme in late December, the swaps market had discounted 190 bp of ECB cuts this year. It had returned to around 140 bp (five quarter-point cuts and a 60% chance of a sixth) in late January, which still seems aggressive compared with ECB signals. Comments from ECB President Lagarde and the record from the December meeting suggest a timeframe of the first rate cute toward the middle of the year. The market thinks April is a reasonable timeframe and will coincide with a sharp drop in measured inflation. With the eurozone continuing to struggle to sustain economic traction, the disruption of Red Sea transit, which means greater costs and slower deliveries, is the latest exogenous shock. Click here for further analysis Economic Calendar February 1: Bank of England February 1: Sweden’s Riksbank February 2: US Employment February 4: China Caixin Services and Composite PMI February 5: Reserve Bank of Australia February 5: Mexico holiday February 6: Japan Household Spending February 7: Reserve Bank of India February 8: US Supreme Court hears case about Colorado ballot February 8: Mexico CPI and Central Bank Meeting February 9: Canada Employment February 9: China Holiday through February 16 February 12: Japan Holiday February 13: US CPI February 13: UK Employment February 14: EMU Q4 GDP February 14: UK CPI February 15: Australia Employment February 15: Japan Q4 GDP February 15: UK Q4 GDP February 15: US Retail Sales February 16: UK Retail Sales February 17: Japan CPI February 18: China One-Year Medium-Term Lending Facility Rate February 19: China Loan Prime Rate February 19: US and Canada Holiday February 20: Canada CPI February 21: FOMC Minutes February 22: Preliminary PMI February 22: Mexico Q4 GDP February 27: Reserve Bank of New Zealand February 27: Australia Monthly CPI February 28: China PMI February 28: US Q4 GDP February 28: Mexico Central Bank Inflation Report February 29: Canada Q4 GDP Bannockburn's World Currency Index, a GDP-weighted basket of the currencies of the 12 largest economies, fell by a little more than 1%. This reflected that most of the components falling against the US dollar in January, retracing some of the gains registered in late 2023. Among the G10 currencies in the BWCI, the Japanese yen was the weakest, falling by a little more than 4.5%, dragged lower, arguably, by the more than 20 bp rise in the US 10-year yield. Sterling was the strongest currency, and it rose by a modest 0.2%. All the emerging market currencies in the BWCI fell, except the Indian rupee, which eked out a minor (0.1%) gain. The South Korean won fell by about 3.6%, the most of the emerging market constituents. The Chinese yuan fell about 1.1%, and among the currencies that declined at the start of the year, only the Russian ruble (-0.5%) and the Mexican peso (-1.05%) in the index fell by less. The BWCI downtrend in January may not be complete, but we suspect the lion's share of the adjustment is behind it. We think that markets are still too ambitious in pricing the timing and extent of Fed rate cuts, and until it adjusts more, there is still upside risk for the dollar, especially as the economic impulses from Europe remain weak. If new initiatives from China get traction, better cyclical news could be forthcoming, even without structural reforms.
The coming weeks will likely continue the correction of the trends that began last month. The markets recognize that tightening cycle is over. However, they swung hard, pricing in aggressive easing by most of the G10 central banks, including the Federal Reserve and the European Central Bank. Official comments and some high-frequency economic data have encouraged participants to rein in their expectations, reducing the odds of a rate cuts in Q1 and paring back the extent of the cuts this year. The pendulum of market expectations reached an extreme. In the first part of January, pricing of the Fed funds futures strip implied a rate cut at each of the remaining seven FOMC meetings. While this is possible, it is not the most likely scenario, especially given what we know about the national labor market and in the context of still elevated price pressures and above trend growth in Q4 23. Similarly, at the extreme in late December, the swaps market had discounted 190 bp of ECB cuts this year. It had returned to around 140 bp (five quarter-point cuts and a 60% chance of a sixth) in late January, which still seems aggressive compared with ECB signals. Comments from ECB President Lagarde and the record from the December meeting suggest a timeframe of the first rate cute toward the middle of the year. The market thinks April is a reasonable timeframe and will coincide with a sharp drop in measured inflation. With the eurozone continuing to struggle to sustain economic traction, the disruption of Red Sea transit, which means greater costs and slower deliveries, is the latest exogenous shock.