USD: Dollar soft as markets lean into December cut
US and European equity futures are firmer this morning as investors position for the Fed’s preferred inflation gauge. The dollar index is trading close to its weakest levels since late October, with futures markets assigning almost a 90% chance of a rate cut next week.
Recent data have sharpened concerns about US growth momentum. November’s Challenger report showed more than 71k job cuts, the highest November figure since 2022, taking year to date layoffs to around 1.1 million, the largest tally since 2020. That followed ADP figures pointing to a 32k fall in private payrolls, underlining softer hiring. Initial jobless claims fell to 191k, the lowest in over three years, although holiday distortions are likely and the four week average is already near its lows for the year. Markets are largely ignoring the claims series and concentrating on the rising layoff trend and weaker hiring signals, which helps explain why the brief rise in US yields and the dollar reversed so quickly.
We judge current pricing for a December move as stretched given the data still to come. The Fed could deliver a cut but pair it with restrictive communication, as seen in September and October, in an attempt to lean against expectations of aggressive easing. That mix would be more supportive for the dollar than current positioning implies.
Today’s focus is on the PCE price index and its core measure excluding food and energy. Consensus looks for a third consecutive 0.2% monthly increase in core, leaving annual inflation just under 3%. Such an outcome would support the view that price pressures are easing but not yet fully contained. Dollar sentiment is also being shaped by speculation that Kevin Hassett could become Fed Chair and tilt the institution in a more dovish direction. For the currency, the key lens is US real rates. Two year real yields, derived from inflation swaps, rose roughly 25bp between September and November as inflation expectations dropped around 50bp. Under a more dovish leadership and recovering inflation expectations, real rates would likely fall, which would point to a softer dollar over time.
In the near term, seasonal patterns and positioning argue for further dollar weakness into year end. We retain year end targets of 1.18 for EUR/USD and 152 for USD/JPY. For today, the delayed core PCE release and consumer sentiment data are the main events, but neither is expected to be a decisive catalyst on its own.
GBP: Sterling rally framed as short squeeze
Sterling continues to grind higher, though we see the move more as a position squeeze than a wholesale rethink of UK fundamentals. The 10 year Gilt swap spread has narrowed from around 58bp in late September to roughly 48bp, a modest tightening that has taken some pressure off UK rates.
We remain modestly constructive on GBP/USD into year end, with a target of 1.34, helped by a slightly weaker dollar backdrop. However, we expect sterling to underperform the euro as the Bank of England begins its easing cycle in December. That should limit how long EUR/GBP trades in the low 0.87 area and points to levels closer to 0.88 or above by year end.
Sterling has benefited as broad pessimism about UK assets has eased and the Gilt curve has stabilised post budget. This has allowed BoE expectations to play a larger role in price action, even though almost a full cut is already priced and investors remain doubtful about how far the Bank can ultimately go into 2026. The MPC has stressed its data dependence and indicated that one soft inflation print is not enough to lock in a more dovish path. A second downside surprise in inflation in the week of the 15 December meeting could materially strengthen the case for easier policy and weigh on the pound.
GBP/USD touched a one month high near 1.34 yesterday, held in check by the 100 day moving average at 1.3369. The pair has broken its downtrend from mid September, having bounced from seven month lows around 1.3010 in early November. Momentum has turned higher and valuations still look somewhat discounted, leaving room for further gains while risk premia remain elevated. With little UK specific data on today’s calendar, sterling traders will also take their cues from the US PCE release. A softer than expected core print would reinforce Fed easing bets and could help GBP/USD clear the 100 day average.
EUR: Constructive tone meets political noise
EUR/USD has extended its recovery, breaking through several important technical levels and holding above its 200 day moving average. Options markets confirm the improved tone, with positioning the most constructive in almost three weeks. The technical picture suggests further upside potential, although a steadier global risk backdrop would probably be needed for the dollar to weaken more convincingly against higher beta currencies.
The broader euro narrative is complicated by geopolitics and European domestic politics. The recent trip by Witkoff to Moscow failed to deliver progress, limiting room for further euro gains in the near term. Within Europe, political risk is edging higher. In France, the budget process remains fragile, while in Germany Chancellor Merz faces internal resistance over a key pension reform. A failure to pass the bill could prompt the SPD to exit the coalition and raise the prospect of early elections. That scenario would put Germany’s stimulus plans at risk and cloud efforts to rebuild the country’s competitiveness.
For markets, the danger is that growing optimism on EUR/USD collides with renewed policy uncertainty. A still soft German recovery, fiscal strains in France and the possibility of relatively cautious ECB staff inflation projections for 2028 at the 18 December meeting could all pull the policy conversation back towards rate cuts. In that case, EUR/USD would be vulnerable to setbacks if political instability and a dovish ECB message arrive at the same time, even if a softer dollar is providing tactical support. For now, we see scope for the pair to test the 1.1700 to 1.1730 region, with initial support near 1.1630 to 1.1640.
Today’s eurozone calendar is light. ECB Chief Economist Philip Lane is due to speak on global imbalances later in the day, likely emphasising the international role of the euro and urging governments to accelerate reforms so the currency can benefit from a more multipolar global system.
Looking ahead
Into year end, markets are balancing three main forces: rising evidence of US labour market cooling, heavy pricing for a near term Fed cut, and growing political risk in Europe. Short term seasonal patterns and position reduction still lean towards a weaker dollar, which underpins our constructive views on EUR/USD and GBP/USD.
The main risk to that narrative is a hawkishly framed Fed cut, or a decision to delay easing if incoming data surprise on the upside. On the European side, any escalation in political tensions or softer than expected ECB inflation projections could limit euro gains and favour relative outperformance of sterling against the single currency, even as the BoE inches towards its own easing cycle.
