Market Update: Dovish Fed Tone Tempers Dollar Gains Amid Strong Macro Data

The US dollar softened during yesterday’s session, influenced by dovish commentary from Federal Reserve officials, despite two strong macroeconomic surprises. While the currency remains positive for the week after a strong start on Monday, it gave up some of its earlier gains. Equity markets retreated from record highs as investors shifted focus to government bonds, with the 2-year Treasury yield declining for the sixth time in seven days to 4.15%—its lowest level since early November.

Following dovish remarks from Fed officials Waller and Williams on Monday, Goolsbee and Kugler joined the discussion, signalling potential openness to a rate cut in December. Despite robust economic data, policymakers seem intent on maintaining a policy easing stance. Market expectations for a rate cut in the next meeting held steady at 74%, reflecting a balance between macroeconomic strength and dovish policy outlook.

US job openings surged in October, rising from 7.37 million to 7.74 million—well above consensus and marking the strongest increase in over a year. This renewed focus on the labour market places significant weight on upcoming data releases, including the employment sub-index of the ISM Services report, the ADP private employment report, and the pivotal non-farm payrolls due later this week.

Euro Under Pressure as France's Political Drama Intensifies

European markets remain fixated on France, where the government faces a critical no-confidence vote on Wednesday. President Emmanuel Macron has urged lawmakers to set aside political divisions to maintain the current administration. However, the rising demand for short-term euro downside hedges suggests a lack of confidence in this outcome. Reflecting the heightened uncertainty, EUR/USD option volatility has reached its highest level since March 2023, with macro hedge funds positioning for potential disruptions from global political risks.

With a light economic calendar in Europe this week, political developments and US macroeconomic events have taken centre stage. The euro’s climb above the key $1.05 level yesterday opens the door for a potential rise to $1.0560, particularly if Federal Reserve Chair Jerome Powell aligns with recent dovish rhetoric. However, a breakout beyond $1.06 would likely require either the French government surviving the no-confidence vote or Friday's US jobs report significantly undershooting expectations. Absent these catalysts, the EUR/USD pair is expected to remain within the $1.0460–$1.0560 range.

British Pound Gains Ground Amid Shifting Market Dynamics

The British pound made modest gains against the US dollar yesterday, extending its climb toward $1.27 this morning despite the backdrop of heightened global political risks. Typically vulnerable in such scenarios, the pound’s recent performance highlights its weakened correlation with traditional risk indicators like equities and the VIX index over the past month.

While GBP/USD has yet to decisively breach the $1.27 mark and remains slightly lower month-to-date, it has shown resilience amid recent political uncertainty. A key factor supporting the pound is the Bank of England’s comparatively hawkish stance. With the odds of a rate cut this month at just 10% and only three 25-basis point reductions expected by the end of next year, the BOE appears less dovish than its G3 counterparts. This stance is mirrored by the Federal Reserve but contrasts sharply with the European Central Bank, where greater rate cuts are anticipated. As a result, GBP/EUR has edged closer to €1.21—a level it has surpassed only 1% of the time since the Brexit vote in 2016.

Looking ahead, relative growth and yield advantages, combined with ongoing political instability in Europe, suggest further upside potential for GBP/EUR.

Korean Won Rebounds Amid Political Turmoil, Highlighting Persistent Volatility Risks

The Korean won erased nearly all its politically-driven losses yesterday after the president briefly imposed and swiftly lifted martial law. However, the political landscape remains tense, with the opposition party now calling for the president’s resignation.

These developments reinforce the view that politically-induced currency volatility will persist. Looking ahead to 2025, escalating trade disputes and rising tariffs are expected to sustain strong demand for options hedging as markets brace for further idiosyncratic risks.

British Pound Faces Headwinds Amid Technical Pressure and Economic Uncertainty

The British pound has entered December—historically one of its strongest months—on a weak footing. GBP/USD dropped nearly 1% on Monday, erasing part of last week’s 2% relief rally that briefly brought the pair back toward $1.28. Now trading closer to $1.26, the pair is testing its 100-week moving average for support.

Fresh tariff threats from U.S. President-elect Donald Trump over the weekend have bolstered the dollar, signalling a potentially more volatile foreign exchange environment in the years ahead. However, Trump’s comments could lead to unpredictable short-term price swings, with the longer-term trend possibly smoothing out in unforeseen ways. The only certainty is increased uncertainty.

Compounding the pound's struggles, UK economic data has softened significantly. Citi’s UK Economic Surprise Index has tumbled from +8 in mid-October to -47, reflecting a steady stream of disappointing figures. This has contributed to GBP/USD’s over 5% quarter-to-date decline. Adding to the gloom, British Retail Consortium data released this morning showed a 3.3% year-on-year drop in retail sales for November.

From a technical perspective, the pound remains under pressure as long as GBP/USD stays below its 200-day moving average, currently near $1.28. A sustained weekly close above this level would challenge the prevailing downtrend. However, a return to a more bullish outlook for the pound will likely require stronger UK economic data—a scenario that has yet to materialise.

European Markets Struggle Amid Political Uncertainty and Diverging Economic Prospects

The potential collapse of the French government is driving bond spreads and implied euro volatility to their highest levels this year. Political uncertainty surrounding France’s budget and Germany’s upcoming February election has left Europe’s two largest economies without majority governments capable of advancing key legislation. This paralysis is making the eurozone less flexible and the euro less appealing to foreign investors.

While European equities have benefitted from positive sentiment out of Asia—where investors reacted favourably to less severe U.S. restrictions on Chinese chips and AI components—the euro has borne the brunt of diverging growth trajectories and rising tariff expectations. The EUR/USD opened below the $1.05 mark, reflecting limited appetite to push the currency higher.

Prime Minister Michel Barnier’s contentious negotiations over the social security funding law could lead to the government’s collapse and the appointment of a new cabinet. The premium on French government bonds over German equivalents has reached 85 basis points, the highest since 2012.

US Economy Shows Strength Amid Key Data Week

The US economy continues to thrive, bolstered by a resilient labour market and robust consumer activity. In October, personal incomes rose by 0.6%, marking the largest increase in seven months. Additionally, initial jobless claims remain historically low at 213,000, providing a positive backdrop as the week unfolds.

Investors face a data-packed agenda, including the ISM Purchasing Manager Indices for manufacturing and services, the JOLTS job openings report, the ADP private employment report, initial jobless claims updates, and the highly anticipated US non-farm payrolls report. Adding to potential market volatility, a dozen Federal Reserve speakers, including Jerome Powell on Wednesday, are scheduled to share insights throughout the week.

Euro Faces Continued Pressure Amid Policy and Political Risks

Last week, the euro experienced a temporary reprieve as selling pressure eased. This was driven by hawkish comments from European Central Bank (ECB) policymakers countering expectations of a 50-basis-point rate cut in December, alongside softer US economic data and favourable month-end flows. As a result, EUR/USD posted its strongest weekly performance since early August. Despite this, the euro's outlook remains bleak. Whether the ECB opts for a 50-basis-point cut this month or later, the currency faces challenges. A cautious stance on easing could amplify concerns about rising yields in France's heavily indebted economy and Germany's economic fragility. Conversely, further rate cuts may widen interest rate differentials, exerting downward pressure on the euro.

Beyond ECB policy, the euro also faces risks from potential tariffs and Germany's upcoming elections. However, the most immediate threat comes from France. Marine Le Pen’s National Rally has issued an ultimatum on Prime Minister Michel Barnier's contentious 2025 budget. Without additional concessions, the party is prepared to back a vote of no confidence in the government as soon as Wednesday.

UK Economy Outperforms as Pound Gains Support

The UK economy continues to outpace much of Europe, with rising inflation prompting expectations that the Bank of England (BoE) will maintain higher interest rates than the European Central Bank (ECB). This policy divergence adds to the pound’s yield-driven appeal. Moreover, the Eurozone’s greater exposure to US tariff policies provides additional upside potential for the pound.

This week, attention will be on the BoE’s Decision Makers Panel, particularly insights into wage expectations and updates from the reweighting of Labour Force Survey data. Final November PMI readings will also be closely watched to confirm whether the sharp drop in sentiment seen in earlier data is sustained.

Month-End Flows Pressure USD

The US dollar's weakness persisted on Wednesday, despite a lack of a clear catalyst. November month-end flows and reduced liquidity due to the Thanksgiving holiday may have amplified the dollar's softer performance. Simultaneously, US Treasury yields continued to trend lower, with the benchmark 10-year yield falling to 4.25%, the lower bound of a range established over the past three weeks.

On the economic data front, attention centred on the Federal Reserve’s (Fed) preferred inflation measure—the PCE index—which aligned closely with expectations on both headline and core readings. However, income growth significantly outpaced forecasts at 0.6% month-on-month, signalling that the factors underpinning robust consumer spending remain strong. Despite this, currency traders largely ignored the data, and the dollar index experienced its steepest daily decline since early August.

The foreign exchange (FX) market has been more volatile this week, partly influenced by news linked to President-elect Donald Trump, likely prompting some consolidation. With US markets closed on Thursday and Friday, any erratic movements in major currencies are likely to be considered as mere noise.

Euro Logs Best Day Since August

The euro recorded its most substantial daily gain against the US dollar since August, buoyed by broad-based dollar weakness and shifting policy expectations. Renewed focus on France’s fiscal challenges highlighted a European narrative of subdued growth and rising yields, which could weigh on the euro. However, the French 10-year yield premium eased from a 12-year high as German yields rose in response to hawkish comments from European Central Bank (ECB) board member Isabel Schnabel.

Earlier on Wednesday, the spread between French and German 10-year bond yields widened to its largest margin since the euro-area debt crisis in 2012. Market jitters were triggered by reports that President Emmanuel Macron indicated Prime Minister Michel Barnier might face a no-confidence vote, while Barnier warned of potential financial market turbulence if his budget proposals were rejected.

Nonetheless, the euro was unaffected by these developments, instead benefitting from traders scaling back expectations of further ECB rate cuts following Schnabel's assertion that the room for additional monetary easing is limited. Holding above the $1.05 mark bodes well for the euro in the short term. However, looking ahead to 2025, we maintain the view that parity trading remains a significant risk due to rate and growth differentials and the potential for renewed trade tariff disputes.

Pound Rebounds from Oversold Levels

The week has been volatile for sterling, driven primarily by external factors as global developments have created a seesaw effect between risk-on and risk-off market conditions. At present, risk appetite appears to be on the rise, bolstering higher-risk assets, including equities, cryptocurrencies, and high-beta currencies like the pound.

GBP/USD has staged an impressive recovery from its six-month low, climbing into the upper range of $1.26 and moving out of oversold territory, as suggested by the 14-day relative strength index. Interest rate differentials support a fair value estimate of $1.29 for GBP/USD, but uncertainties surrounding global trade tensions could easily push sterling lower should fresh tariff concerns dampen market sentiment. In the near term, weak seasonal trends for the dollar and month-end flows favouring USD selling could see GBP/USD edge closer to its 50-week and 200-day moving averages, around $1.28.

Against the euro, sterling remains tethered near the €1.20 level, fluctuating within a narrow 1.3% range for most of the month. Excluding the fallout from the UK’s mini-budget in 2022, the UK-German two-year yield spread is near its highest point since 2005. This adds to the upside potential for GBP/EUR as money markets anticipate the ECB cutting rates nearly twice as much as the Bank of England by the end of next year.