Canadian Dollar Heads South

US SME Optimism Surges to 44-Year High

The US dollar rose for a third consecutive day as sentiment among small businesses turned positive, according to the first data release since Donald Trump’s election victory. Investors are now awaiting significant Treasury auctions over the next two days, alongside the crucial inflation report due later today.

Trump has long been viewed by investors as favourable to small and medium-sized enterprises (SMEs) in the United States. This perception has been evident throughout 2023 and 2024, during which the small-cap equity index Russell 2000 closely mirrored Trump’s rising election odds. One particularly well-received initiative was the 20% business tax deduction introduced during his first term. The sharp rise in SME sentiment following his re-election suggests smaller firms are prepared to overlook planned tariff increases and are instead focusing on the promised reduction of bureaucracy and deregulation initiatives. While actual sales figures remained unchanged in November, the outlook for general business conditions over the next six months soared to a record high, as per the NFIB survey published this week.

Attention now turns to the Consumer Price Index (CPI) report later today. Economists anticipate another strong monthly increase of 0.3% for November, matching October’s gain. The annual core inflation rate is expected to remain steady at 3.3%, while headline inflation may edge higher from 2.6% to 2.7%. Investors are likely to scrutinise the data closely, even though market volatility has declined markedly since 5 November—more so than is typical following presidential elections.


Pound Reaches Strongest Level Against Euro Since 2022

The pound has outperformed its G10 counterparts for much of 2024, buoyed by a UK economy that has proven more resilient than expected and expectations that the Bank of England (BoE) will adopt a cautious stance on cutting interest rates. This contrasts starkly with Europe, where economic growth has been lacklustre and the European Central Bank (ECB) has maintained a dovish policy. Consequently, GBP/EUR has climbed above €1.21, its highest level since March 2022.

The divergence between the BoE and ECB is expected to persist through 2025. Markets currently price in just three rate cuts by the BoE compared to six for the ECB. As a result, the yield spread between UK and German bonds has widened from 120 basis points to over 220 basis points in just a few months. Simply put, the pound offers a more attractive yield than the euro. Adding to the euro’s challenges are European political uncertainties, while the UK’s goods trade deficit with the US renders it less vulnerable to Trump’s tariff policies than the Eurozone.


Canadian Dollar Weakens Ahead of BoC Decision

The Canadian dollar fell to a four-and-a-half-year low against the US dollar yesterday, ahead of today’s Bank of Canada (BoC) policy decision. While a 25 basis point rate cut is fully priced in, 80% of swap traders now anticipate a larger 50 basis point reduction.

Last week’s disappointing Canadian employment data tilted expectations further in favour of a 50bp cut. This has driven USD/CAD up by over 1%, briefly surpassing the C$1.42 mark—its weakest level since April 2020. Widening rate differentials between Canada and G10 peers such as the US and UK have also contributed to this decline, with both the US dollar and particularly sterling on track to post their largest yearly gains against the Canadian dollar since 2015. Additionally, Canada’s sizeable trade surplus has placed it in the crosshairs of Donald Trump, whose tariff threats are weighing on both the Canadian dollar and the broader economic outlook.

While risks to the Canadian dollar remain tilted to the downside, a relief rally could materialise if policymakers adopt a less dovish stance than expected. In such a scenario, a pullback towards the C$1.40 level could occur. However, a move higher towards C$1.45 appears unlikely unless Canada faces significant tariff impositions from Trump in 2025.

China stimulus

Risk-On, Risk-Off

Currency traders have raised the likelihood of a Federal Reserve (Fed) interest rate cut this month to 86%, following Friday’s mixed US employment report. The next major data point will be November's US inflation figures, due on Wednesday, as Fed officials observe a blackout period ahead of the central bank’s meeting a week tomorrow. The US dollar has edged lower alongside Treasury yields, though geopolitical tensions are tempering its decline, as markets fluctuate between risk-on and risk-off sentiment amid developments in China.

Despite the dollar’s recent loss of momentum—having fallen nearly 2% since its November peak—driven by growing expectations of future Fed rate cuts, it remains a favoured safe haven during periods of heightened geopolitical uncertainty. While China’s most significant monetary easing in over a decade has supported risk assets, its intensifying trade conflict with the US has curbed broader risk appetite. China recently announced it would cut off key drone supplies to the US and Europe, which have been instrumental in Ukraine’s defence against Russia. This escalation in geopolitical risks, alongside tariffs and protectionist policies, is likely to keep currency market volatility elevated. Still, attention also remains on macroeconomic and monetary policy trends.

Although the US dollar and short-term Treasury yields have diverged somewhat since the US elections, their positive correlation remains unusually strong. This dynamic could spell trouble for the dollar if falling yields continue to fuel rate-cut expectations over the coming year.

Additional Stimulus from China

The euro has climbed well above the $1.05 level, recovering from its yearly low near $1.0330 reached at the end of November. European developments continue to weigh on the currency, with political uncertainty and disappointing macroeconomic data presenting challenges.

The euro’s rebound can largely be attributed to shifts in US markets, where a peak in surprise economic data, lower bond yields, and a moderation in Fed expectations have prompted a repricing of the dollar. This adjustment has benefited the EUR/USD exchange rate.

A potential driver for further recovery lies in China. Beijing has pledged to bolster economic growth in 2025 through increased fiscal stimulus and a moderately loose monetary policy. These measures aim to offset the negative effects of heightened US tariffs. Investors are optimistic about further supportive announcements during the Central Economic Work Conference on Wednesday. While Chinese equities surged by approximately 3%, the rally in European assets lost momentum during Monday’s session.

Key Resistance for Sterling

The pound strengthened at the start of the week, moving in tandem with other risk-sensitive currencies following China’s shift towards a looser monetary policy. Sterling shook off weak UK labour market data and gained from improved global risk sentiment, with GBP/USD nearing $1.28 and GBP/EUR approaching €1.21.

UK labour market surveys revealed the fastest decline in job vacancies since August 2020, as businesses face the dual pressures of rising employee costs and a subdued economic outlook. Business confidence, according to BDO, has fallen to its lowest level in nearly two years. The slowing jobs market, combined with a larger pool of candidates, could ease wage pressures, which would be welcomed by the Bank of England (BoE). However, it may also lead to a more dovish monetary stance for 2025 than markets currently anticipate, potentially weighing on the pound.

Sterling remains supported by relatively high yields compared to most of its G10 peers, but any dovish reassessment of BoE policy could weaken the currency. The 200-day moving average for GBP/USD, currently at $1.2819, acted as a resistance point during Friday’s bounce following the US jobs report. A break above this level would be a key technical milestone, potentially paving the way for further gains in the pound and pushing GBP/EUR past €1.21.

Monfor Weekly Update

GBP starts the week with a positive outlook against the EUR, supported by political uncertainties in the Eurozone and expectations that the Bank of England (BoE) will implement fewer interest rate cuts than the European Central Bank (ECB). The GBP/EUR exchange rate remains near 2024 highs, with technical indicators pointing to further upside. Trading above key moving averages and with a rising Relative Strength Index (RSI), the pair could test the 1.2090 resistance level, with potential for further gains if Thursday’s ECB decision signals a dovish stance.

The ECB meeting is this week’s main event, with markets largely anticipating a 25 basis point rate cut, though a deeper 50 basis point cut could weaken the Euro further. Should the ECB opt for caution, the Euro might find some support, tempering GBP/EUR gains. As a result, the tone of the ECB’s messaging will play a key role in determining the pair’s direction, particularly as it approaches its two-year high at 1.2103.

Domestic factors also weigh heavily on the Pound, with UK GDP data on Friday expected to show a 0.1% contraction for October. A deeper decline could pressure Sterling, while a stronger-than-expected reading might bolster it. Consumer sentiment, via the GfK index, will also be scrutinised for signs of deterioration post-budget, adding another layer of influence to GBP performance.

Looking ahead, next week’s UK inflation and labour market data will be pivotal for BoE policy expectations. Against the USD, GBP has held near 1.28 as signs of cooling in U.S. labour market momentum emerge. However, with the prospect of fewer Federal Reserve rate cuts in 2025, the Dollar could remain supported, capping GBP/USD gains. Overall, the Pound has room for near-term strength, but outcomes hinge on key data and central bank decisions this week.

Dollar Weakens as Attention Turns to Labor Market

Market Update: Dollar Weakness and Focus on US Jobs Report

Yesterday’s trading session saw significant broad-based dollar weakness, with the currency losing ground against all G10 peers. Investors are positioning ahead of today’s highly anticipated US non-farm payrolls (NFP) report, widely regarded as the most crucial global macroeconomic release of the month. Market consensus forecasts a 200,000 job gain in November, following a modest increase of only 12,000 jobs in October. Traders are hedging against the possibility of the data missing expectations.

Federal Reserve Chair Jerome Powell’s Wednesday speech had little impact on market expectations for rate policy, with options markets still pricing in a 70% probability of a December rate cut. Meanwhile, equity markets retreated on Thursday, following the S&P 500's 56th record close this year, as weekly jobless claims rose to a one-month high. The labour market remains a key driver of market sentiment, and today’s jobs data will provide investors with a clearer snapshot of employment dynamics.

The US dollar is on track for a second consecutive weekly decline after eight weeks of gains. Similarly, the two-year Treasury yield has fallen from 4.38% to 4.15% over the past two weeks, reflecting shifting sentiment in fixed-income markets.

European Markets Open Lower Amid Political and Economic Concerns

European equity markets are set for a weaker open today, weighed down by ongoing political unrest in France. The euro remains under pressure as traders navigate uncertainties surrounding the European political landscape, diverging monetary policies between the ECB and the Federal Reserve, and the potential impact of higher tariffs, which could exacerbate challenges for the Eurozone economy.

Adding to the gloom, Germany’s industrial production fell by 1% in October, missing expectations of a 1% recovery. This followed a revised 2% decline in September, deepening fears of a winter recession in Europe’s largest economy. Investors are also watching for the third-quarter Eurozone GDP data, though it is not expected to significantly influence markets. Next week, the ECB is anticipated to implement its fourth rate cut of the year. Unlike earlier moves, the size of this cut is uncertain, with discussions hinting at a possible 50 basis point reduction due to a weaker growth outlook despite inflation meeting targets.

In currency markets, the EUR/USD pair is flat for the week, having rebounded from below $1.05 at Interbank (IB), mainly due to broad dollar weakness. However, the euro’s downward trend remains intact beneath the $1.06 IB level, making this week’s close critical. Against the pound, the euro continues to face challenges, with GBP/EUR holding above €1.20 IB for the third consecutive week. Meanwhile, FX options pricing reflects heightened demand for protection against short-term swings in the euro, reaching levels last seen in March 2023.

GBP/USD Near $1.28 at IB: A Turning Point in the Multi-Month Downtrend?

The British pound has gained for three consecutive days against the US dollar, climbing over 2% from its recent low below $1.25 IB. GBP/USD is now trading just 50 pips short of the $1.28 IB level, a key resistance marked by the 200-week moving average at $1.2820 IB. A weekly close above this level could challenge the pair’s multi-month downtrend.

Today’s US payrolls report could serve as a potential catalyst for further gains. Domestically, the UK’s November Decision Maker Panel highlighted rising inflation expectations, increased price-setting plans by firms, and persistently strong wage growth. This marks a shift from the downward trends observed over the past 18 months, suggesting the Bank of England (BoE) may opt for gradual rate cuts due to continued inflationary pressures. These factors have supported the pound, with favourable UK-US rate differentials limiting sterling’s downside since the last election.

However, GBP/USD remains undervalued compared to the UK-US 2-year yield spread, with the pair more influenced by US developments, including the market’s pricing of Federal Reserve policy expectations.

For GBP/USD to solidify a more bullish outlook, stronger UK economic data and weaker US data will likely be needed. While the international backdrop remains fluid, the pair’s trajectory is closely tied to shifting macroeconomic trends on both sides of the Atlantic.

French Government Collapses

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.

 

Please note:  The news and information contained on this site should not be interpreted as advice or as a solicitation to offer to convert any currency or as a recommendation to trade.

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