USD: Data wobble, labour costs ease, payrolls decide

December US retail sales were unchanged on the month, with the control group slightly weaker. After a solid November, some payback was always likely, and the headline is unadjusted for inflation, so seasonal discounting can mechanically depress nominal sales. Historically, flat Decembers are not unusual, which helps keep the signal contained. The immediate USD response was limited.

More notable was the Q4 Employment Cost Index, which cooled to 0.7% q/q, the softest pace in four years. That is the kind of disinflationary impulse the FOMC is more likely to respect, given the pass-through from labour costs to corporate pricing. Even so, Fed communication following the January meeting has set a firm baseline, and we still see USD asymmetry: the dollar is likely to react more to downside surprises than upside beats.

Positioning looks to be stabilising rather than stretched. CFTC data (as of Tuesday, 3 February) suggest leveraged funds have moved back towards modest net long exposure in DXY after previously flipping bearish during the policy-driven selloff. With macro releases resuming, this week’s data should either reinforce that tentative shift or unwind it quickly. DXY remains softer on the week, helped by JPY strength, but the broader tone still reflects residual scepticism towards the greenback.

Today’s US jobs report is the clear catalyst. A genuinely weak outcome would revive near-term cut pricing and could pull DXY towards the mid-96 area. Our base case is firmer than consensus on payrolls, with the unemployment rate seen steady at 4.4% and limited drama expected from revisions. Even if the print is supportive, we doubt it sets up a durable USD rebound, and would treat any DXY lift as corrective rather than structural.

GBP: Domestic politics weighs on crosses, but GBP/USD remains a dollar trade

Sterling has struggled against most peers as UK political noise intersects with softer Bank of England expectations. The price action is clearer in GBP/EUR than GBP/USD, where the pair is behaving primarily as a proxy for USD sentiment rather than UK fundamentals.

Options markets are flagging event risk into the US payrolls release. Overnight implied volatility is elevated and pricing implies a larger-than-usual move, while skew indicates greater demand to hedge against GBP weakness than strength. That speaks to defensive positioning rather than a firm directional call.

On the charts, GBP/EUR slipped below its 50-day moving average near 1.1467, a technically meaningful break that suggests the post-budget bounce has faded and near-term risks have tilted lower. Political pressure on the Prime Minister appears to have eased somewhat after cabinet backing, but debate within Labour about shifting policy leftwards risks keeping a risk premium in GBP if fiscal credibility becomes a market concern.

We remain constructive on EUR/GBP, reflecting political uncertainty and our expectation for two BoE cuts by June. In that framework, 0.88 remains a plausible near-term objective.

EUR: Benefiting from diversification flows, but still driven by the US tape

The euro continues to draw support from diversification away from US assets, helped by its liquidity within G10. EUR/USD has been trading above our fair value estimate near 1.18, with US policy uncertainty continuing to cap USD enthusiasm.

What is changing is that fundamentals may now start to validate the flow story. Softer US labour indicators last week and the flat retail sales print have nudged rate expectations in a more dovish direction, leaving EUR/USD highly sensitive to any further signs of slowing momentum.

Options pricing is notable: the EUR/USD risk profile is tilted towards EUR calls, signalling greater demand for protection against further upside than for downside cover. That is a positioning and hedging signal rather than a forecast, but it underlines the market’s discomfort with being under-hedged for a higher EUR/USD outcome. Euro area inputs are light and recent ECB communication has not clearly framed EUR strength as a near-term problem.

If EUR/USD pushes above 1.20 on soft US data, some policymakers may revive discussions around FX-sensitive easing. Our sense is that the threshold for meaningful discomfort is closer to 1.25, where the drag on inflation projections becomes harder to ignore. Near term, we see payrolls risk pulling EUR/USD back towards a 1.18 anchor.

Looking ahead

• US payrolls: market pricing is highly sensitive to a downside surprise; watch unemployment and earnings alongside the headline.

• Fed repricing: any shift towards earlier cuts would likely pressure DXY quickly, while upside surprises may deliver only modest USD support.

• EUR/USD levels: 1.18 remains a near-term anchor; 1.20 is the next psychological and policy-sensitive area.

• GBP crosses: GBP/EUR remains the cleaner read on UK risk; watch whether the break below the 50-day average holds.

• Options signals: elevated overnight implied vol in GBP/USD and call-heavy EUR/USD hedging suggest sharp moves are being priced, not certainty of direction.