European Markets Show Resilience Amid Political Turmoil
Despite the collapse of the French government and the ousting of Prime Minister Michel Barnier in a no-confidence vote, equity markets and the euro posted gains in yesterday’s session. Fiscal policy remains a central focus for European policymakers this year, having already triggered the downfall of two governments—France and Germany. Both nations are now in a political limbo, unable to implement critical legislation. Interestingly, the euro appeared to have anticipated the French political upheaval, climbing to around $1.0520 following the no-confidence vote.
Meanwhile, significant attention has turned to predictions of the EUR/USD pair dropping to parity in the coming months. Although such risks have been on the radar since early November, this scenario is not yet the baseline forecast. The euro's recent decline aligns with underlying factors such as nominal and real interest rate differentials, economic sentiment, central bank policies, inflation expectations, and relative yield curves.
This underscores that markets have effectively priced in the political uncertainty in Europe and the policy divergence between the European Central Bank (ECB) and the U.S. Federal Reserve, particularly against the backdrop of anticipated higher tariffs. With the macroeconomic landscape relatively balanced, political developments are set to take centre stage.
Mixed US Data and Fed Commentary Keep Dollar in Check
The US dollar index struggled for direction yesterday following a mix of economic data and a series of Federal Reserve comments. ADP employment figures for November came in close to expectations, offering little momentum for the dollar. However, the ISM services index saw a sharp decline, pulling both yields and the dollar off their intraday highs. While bearish pressures on the dollar remain limited, continued softer economic data supporting rate cuts could weigh more heavily going forward.
A closer look at the ISM report revealed weaker-than-expected new orders and employment, while prices paid showed unexpected resilience. This divergence highlights a contrast between the services and manufacturing sectors. As a services-driven economy, the U.S. may see greater significance in the disappointing services data, even though the sector remains in expansion territory.
Federal Reserve Bank of St. Louis President Alberto Musalem added nuance to the outlook, suggesting it might be time to slow the pace of rate cuts, citing persistent inflation and easing concerns about the labour market. These hawkish remarks likely helped mitigate dollar losses despite the weaker data.
GBP/USD Climbs Back Above $1.27 Despite Dovish BoE Outlook
After a pullback driven by Bank of England (BoE) Governor Andrew Bailey’s dovish remarks, GBP/USD rebounded above $1.27, aided by disappointing US economic data that weighed on the dollar. A sustained move above this level could pave the way for a test of the 200-day moving average at $1.2818 in the near term. Historically, December tends to favour the pound, though challenges loom for Q1 next year.
Governor Bailey emphasized the BoE’s intent for “gradual” rate cuts, suggesting reductions of 25 basis points per quarter through 2025, totalling 100 basis points. This contrasts with the 80 basis points currently priced in by overnight indexed swaps. If markets align with the BoE’s outlook and fully price in four cuts rather than three, sterling’s appeal as a higher-yielding currency could diminish. Alongside geopolitical and trade uncertainties, this represents a significant headwind for the pound.
For now, sterling remains buoyed by its relatively high rate differential, with only a 10% probability of a BoE rate cut priced in for this month. However, the broader FX landscape continues to reflect geopolitical and economic risks that could influence future movements.
