Consumer Confidence Decline Fuels Fed Easing Expectations

Adding to the pressure on the U.S. dollar and expectations for Federal Reserve easing was the release of the Conference Board's consumer surveys on Tuesday. The data revealed that consumer confidence fell significantly below forecasts, coming in at 98.7 compared to the anticipated 104 for the month. Attention also focused on the labour market differential metric, which tracks the gap between the percentage of consumers who believe jobs are plentiful and those who think jobs are hard to find. This gap continued to widen, suggesting a higher U.S. unemployment rate in the September jobs report, due next Friday.

The Federal Reserve had projected the unemployment rate to rise to 4.4% by year-end. If it exceeds this level, as the data indicates, the market may be justified in anticipating another 50 basis point rate cut during the Fed's November or December meetings.

Sterling's Bullish Momentum Continues in Q3

The strong performance of the British pound from the first half of the year has extended into the third quarter, supported by positive UK economic data, including this week's PMI reports. With expected growth differentials influencing G10 currencies, the pound has benefited from its attractive yield appeal. Additionally, heightened risk appetite has further boosted sterling. As a result, GBP/USD has risen above $1.34 and GBP/EUR above €1.20, both reaching over two-year highs.

This doesn’t rule out GBP/USD extending towards $1.35, but the upward momentum may begin to fade sooner, especially if we see increased FX volatility due to month- and quarter-end flows this week.

Euro Rebounds on China Stimulus, but Economic and Political Risks Loom

The euro bounced back after briefly dipping below $1.11 at the start of the week, lifted by improved global sentiment following China’s announcement of an economic stimulus plan aimed at meeting year-end growth targets. European stocks rallied, with the French CAC 40 climbing over 1% to a three-week high, driven by gains in the luxury sector, which stands to benefit from China’s recovery efforts. However, European bonds faced selling pressure amid this risk-on environment.

Despite the market’s positive reaction, underlying concerns about the Eurozone economy persist. Germany’s business outlook has deteriorated, with the Ifo institute’s expectations index falling to 86.3 in September, its lowest since February, while the current conditions index dropped to a four-year low of 84.4. These disappointing figures, along with weak flash PMIs and declining business and consumer sentiment across the Eurozone, have fuelled expectations of a European Central Bank (ECB) rate cut in October. The probability of a cut, reflected in the OIS curve, has risen from 40% to 63% this week, despite opposition from some ECB officials. While ECB’s Muller acknowledged the potential for a rate cut, he warned that there may not be enough data to support a definitive decision by next month.

Adding to the euro’s challenges is political uncertainty in France. The 10-year OAT-Bund yield spread has widened to 78 basis points, the highest since August, as investors grow concerned over France’s delayed budget and the threat of a no-confidence vote. Prime Minister Barnier’s government faces an October 1 deadline to submit the budget for parliamentary debate, with potential for further political instability. Additionally, Fitch and Moody’s are set to review France’s fiscal health on October 11 and 25, following an earlier downgrade by S&P Global. These factors are contributing to a higher risk premium for French debt and could weigh on the euro in the weeks ahead.

British Pound Surges Above €1.20 Amid Diverging Economic Recoveries

The British pound has climbed above the crucial €1.20 mark against the euro, fuelled by flash PMIs that reveal a widening gap between the UK and its European counterparts in economic recovery. Political uncertainty is weighing on the euro, while China's contribution to the global risk rally has bolstered the pound, which is seen as pro-cyclical and risk-sensitive.

UK PMI surveys presented mixed results on price indicators, with stronger figures in manufacturing but weaker ones for services prices. On the labour market side, the data showed a decline in employment, as the composite employment index dropped 1.5 points to 50.6. Despite signs of slowing momentum in the UK's recovery at the end of Q3, the headline indices remain strong relative to the rest of Europe. Another contributing factor to the pound's strength is the interest rate differential, with the Bank of England's cautious approach to rate cuts providing a yield advantage that makes the pound attractive to investors. As a result, GBP/EUR is at its highest level since April 2022, up nearly 4% since early August.

The pound has also reached new 31-month highs against the US dollar, trading between $1.33 and $1.34. With limited technical resistance until $1.35 and the euro looking less appealing, the pound is well-positioned to benefit from any further weakness in the dollar.

Euro Slips Below $1.11 Amid Rising Concerns Over ECB Monetary Easing

The euro briefly dipped below $1.11 on Monday as fears intensified that the European Central Bank (ECB) may need to accelerate monetary easing to address the weakening Eurozone economy. The flash Eurozone composite PMI fell for the fourth consecutive month, dropping to 48.9 in September—its lowest level since January—from 51 in August. This marked the first contraction in private sector activity in seven months. Manufacturing output continued to struggle, particularly in Germany and France, declining for the 18th straight month (44.5 vs. 45.8). The services sector, which had been supporting the economy, also experienced a sharp slowdown, especially in France. Additionally, input cost inflation hit its lowest level since November 2020, while output prices saw their smallest rise since February 2021.

In response to the weak PMI data, market expectations for an ECB rate cut in October increased, with the OIS curve now pricing in a 10bps cut, up from 6bps last week. Around 50bps of cuts are now anticipated by the end of the year, signalling the possibility of a larger rate cut in December if no action is taken soon. However, several hawkish ECB members, such as Kazaks, have opposed immediate cuts, emphasizing the ongoing challenge of persistent inflation, particularly in the services sector. Kazaks also raised concerns about the risks of keeping rates too high for too long, echoing the warnings of Centeno, a dovish ECB member, who last week highlighted the threats to economic growth.

BoE’s Policy and Political Shifts Strengthen Positive Outlook for Pound

The Bank of England's (BoE) decision to maintain a hawkish stance last week has further supported the pound’s positive momentum. By sticking to a slower rate-cutting cycle compared to other major central banks, the BoE is helping preserve the pound’s carry advantage. As a result, GBP/USD is holding above $1.33, near 31-month highs and up over 4% year-to-date, while GBP/EUR has surpassed €1.19, approaching 2-year highs and up more than 3% this year.

Beyond monetary policy, the UK government's move toward strengthening EU-UK relations should provide structural support for sterling. However, potential challenges loom ahead, including the upcoming Budget and the risk of anti-growth measures, which could create short-term downside pressure. While the Labour Party's conference this week may offer insights on policy, the market’s main focus will be the Budget on October 30. Attention will also be on the flash PMIs for September, particularly the manufacturing index and service sector price trends, given the significance of services inflation to the BoE.

Absent any significant external shocks, the pound is expected to continue outperforming among G10 currencies in the coming months, with the possibility of GBP/USD reaching $1.35 and GBP/EUR breaking through €1.20.

Fed's Rate Cut Boosts Risk Markets but Signals Fewer Cuts Ahead

The US Federal Reserve’s recent 50 basis point rate cut has bolstered risk markets and high-beta currencies, while also increasing the chances of a soft landing and fewer future rate cuts than anticipated. Despite this, the US dollar index remains anchored near 2-year lows, as the impact of lower rates continues to weigh on the currency.

The Fed maintains that the disinflation trend is intact and has shifted its focus to addressing rising unemployment as the labour market shows signs of weakening. In the immediate aftermath of the decision, the initial risk rally faded after Fed Chair Powell warned against expecting further significant cuts. However, the Fed significantly revised its outlook for US interest rates, projecting lower rates by the end of this year and next. This shift is expected to sustain a positive environment for risk sentiment, benefiting cyclical currencies in the near term.

Euro Underperforms Against US Dollar Amid Weaker Economic Outlook

The euro has lagged behind the pound in its performance against the US dollar this year. This underperformance is primarily due to the Eurozone's weaker economic conditions compared to the UK, coupled with expectations of more aggressive rate cuts by the European Central Bank (ECB) over the coming year compared to the Bank of England (BoE). As a result, despite several attempts, EUR/USD has been unable to sustain a break above the $1.12 level, except for a brief period of six days in July 2023.

Sentiment Improves as Markets Settle

US stocks surged yesterday, with the S&P 500 climbing 1.7% to a new record high and the Nasdaq up 2.4%, as investors continued to digest the Federal Reserve’s latest decision. The Fed implemented a significant 50-basis point rate cut, the first in four years, and hinted at further reductions this year and next.

While the Fed maintains that disinflation persists, they have made addressing rising unemployment a priority as the labour market softens. Although initial enthusiasm faded after Fed Chair Powell warned against assuming further large cuts, markets still anticipate another 70bps reduction by year-end, compared to the Fed’s forecast of 50bps. Despite this, higher long-term Treasury yields have kept the rally in check. Interestingly, US jobless claims fell to 219,000, the lowest since May, suggesting the labour market may not be weakening as much as expected, making another large cut less certain. However, if the Fed prioritises market sentiment, the dollar could remain on the back foot.

Yen Strengthens After BoJ Decision

The Bank of Japan (BoJ) held interest rates steady on Friday, opting for caution despite August's inflation data showing a fourth consecutive month of acceleration. As expected, the yen strengthened slightly, rising by around 0.2% against both the US dollar and euro.

Since its surprise rate hike in July, the yen has gained about 11% against the dollar, and although it has experienced losses this week, the narrowing rate differentials in favour of the yen point to further strength as we approach year-end. With more rate hikes expected from the BoJ, while other central banks shift towards cuts, the yen is likely to continue its upward trajectory through 2024.

Pound Approaches Multi-Year Highs

The Bank of England left interest rates unchanged at 5% on Thursday, as anticipated, with an 8–1 vote from the Monetary Policy Committee. This bolstered the pound, pushing GBP/EUR towards €1.19 and GBP/USD above $1.33 for the first time since early 2022.

Governor Andrew Bailey stressed the importance of keeping policy restrictive for a prolonged period, and the narrowing rate differentials between the UK and US suggest further gains for the pound in the coming months. Positive UK retail sales data provided additional support, though signs of economic moderation and weakening consumer confidence ahead of the autumn Budget may limit further upside. Tighter fiscal policy could dampen growth prospects, potentially prompting a dovish shift from the BoE, which may pose risks to sterling if expectations for rate cuts accelerate.

Euro Momentum Slows Below $1.12

The euro edged higher following the Fed's rate cut and a series of ECB speeches. While eurozone stocks rallied and bonds outperformed US Treasuries, the euro itself remained subdued.

ECB speakers expressed mixed views, with hawks resisting further cuts and doves suggesting faster rate reductions if inflation undershoots forecasts. Markets are now pricing in deeper ECB cuts by 2025, mirroring expectations around Fed policy easing. Meanwhile, political concerns in France have resurfaced, as the country missed a deadline to present a credible debt-reduction plan, which pushed the 10-year French OAT-Bund spread to a monthly