The Fed's Data Dilemma Leaves FX Markets in Limbo
The foreign exchange (FX) market is currently navigating a period of uncertainty, largely due to the Federal Reserve's indecision about a potential interest rate cut in December. This hesitation has intensified the focus on economic data releases, leading to a peculiar situation: subdued volatility during data lulls and potentially exaggerated reactions to any labor-related indicators, such as the upcoming ADP report. Despite this, our analysis suggests the US dollar is nearing its peak.
USD: Awaiting ADP with Bated Breath
This week's narrative revolves around reevaluating the likelihood of a Fed rate cut in December. This reassessment began with Chair Powell's press conference last Wednesday and continues with insights from FOMC members and the limited data available. The dollar has already strengthened due to a 7 basis point hawkish adjustment in the December Fed Funds futures contract. However, with 16 basis points still priced in, a rate cut remains the market's base case, leaving room for further hawkish revisions. While we maintain a dovish Fed/bearish USD stance, the risks are now more evenly balanced.
Recent comments from Fed officials indicate reduced confidence in a predetermined easing path, suggesting increased data dependency. December's meeting has been characterized as a 'live meeting' by the dovish Lisa Cook, and Mary Daly emphasized the need for the FOMC to maintain an 'open mind.' The challenge, however, arises from the government shutdown, which has disrupted the regular data release schedule, leaving no clear end in sight. Consequently, the few data points available, particularly tomorrow's ADP report, could have a disproportionate impact on markets. Meanwhile, the overall scarcity of data may result in more periods of directionless FX trading.
But here's where it gets controversial... With JOLTS data absent today, rangebound trading may persist until tomorrow's critical ADP figures. Michelle Bowman, a dovish Fed speaker and potential chair candidate, is one to watch. If she adopts a cautious tone regarding December, it could trigger further hawkish repricing and bolster the USD. This raises the question: Is the market underestimating the potential for a December rate cut, or is the Fed's data dependency a red herring?
USD/JPY: A Tale of Intervention and Safe-Haven Demand
This morning, USD/JPY experienced a significant decline, likely driven by verbal FX intervention from Japan's finance minister and a drop in global equity futures. This highlights the yen's enduring role as a safe-haven currency, despite recent lackluster demand. It also underscores how extensive short positioning on the JPY can fuel rapid rallies. This situation prompts the question: Is the yen's safe-haven status overstated, or is it a reliable hedge in times of uncertainty?
EUR: ECB Unity and the Case for a Rally
Recent ECB speakers have largely reinforced the existing policy narrative, with the Governing Council aligned on interest rates. Significant data surprises would be needed to create new divisions among policymakers. While we anticipate the possibility of another rate cut, the risks are currently low, and we believe the easing cycle is nearing its end.
Despite the hawkish repricing in the USD curve, the EUR/USD decline appears excessive. Our short-term fair value model indicates a 1% undervaluation, and with more balanced positioning, the pair could rally swiftly on weak US jobs data. We remain optimistic about a year-end rally to 1.18-1.20, but this hinges on US data signaling a rebound. Is the market overly pessimistic about the euro's prospects, or is a rally premature without clearer US economic signals?
CAD: Budget Announcement and the Loonie's Outlook
Canada's budget announcement today warrants attention, as fiscally expansionary measures to support a tariff-affected economy are expected. Concerns about debt sustainability are unlikely to impact the CAD significantly, so bold fiscal spending should be positive, reducing the likelihood of further Bank of Canada rate cuts.
However, the focus remains on data. If inflation figures fall short, the case for another cut in early 2026 (our baseline) becomes more compelling. Friday's October jobs report will also be crucial, with the unemployment rate taking center stage. Any increase from the current 7.1% could fuel dovish expectations.
We expect USD/CAD to trade around 1.40 for most of November, followed by a decline in December as the USD weakens. Is the Canadian dollar undervalued, or are there hidden risks that could derail its performance?
CEE: A Region in Anticipation
Yesterday's PMI data painted a mixed picture for the region, with the Czech Republic underperforming expectations, while Poland and Hungary surprised on the upside. Turkish inflation surprised the market by declining to 2.6%/32.9%, aligning with our estimate and resuming its downward trend. We project the annual inflation rate to reach around 32% by the end of 2025 and decelerate to approximately 22% next year, compared to the CBT's interim target of 16%. The balance of risks remains tilted to the upside. October's data supports another rate cut in December, with the magnitude dependent on November's inflation figures. We anticipate a 100 basis point cut in December, bringing the policy rate to 38.5% by year-end, which should not disrupt the TRY's stable depreciating path or the CBT's FX policy.
Today's calendar is quiet ahead of a busier second half of the week, featuring inflation data from the Czech Republic on Wednesday and meetings of the National Bank of Poland and the Czech National Bank on Wednesday and Thursday. CEE currencies started the week positively, with gains for the CZK and HUF. EUR/CZK remains within a tight 24.250-400 range, showing no signs of change despite this week's CNB meeting. EUR/HUF, however, tested new lows yesterday, briefly touching 387, indicating market acceptance of current levels despite weaker data and fiscal headlines. We believe the market is increasingly pricing in more NBH rate cuts at the front end of the curve, given the HUF's strength and anti-inflationary pressures.
And this is the part most people miss... As CEE economies navigate these dynamics, the question arises: Are Central and Eastern European currencies undervalued, or is the market correctly pricing in the region's economic realities? We invite you to share your thoughts and engage in the discussion below.
