Market Brief: Currency Traders Brace for Tumultuous Week

Foreign exchange markets are looking deeply rangebound this morning as 2024’s last full trading week kicks off. Most major currencies are trading within a quarter percentage point of Friday’s close, Treasury yields are stable, and North American equity markets are setting up for modest losses at the open.

The euro is trading on a slightly softer footing after Moody’s Ratings cut France’s credit rating, warning that growing political dysfunction could endanger the country’s borrowing capacity. According to a statement released by the agency on Friday, “the country’s public finances will be substantially weakened over the coming years. This is because political fragmentation is more likely to impede meaningful fiscal consolidation” with an inability to pass a budget meaning that “There is now a very low probability that the next government will sustainably reduce the size of fiscal deficits beyond next year”. President Emmanuel Macron appointed Francois Bayrou as caretaker prime minister earlier in the day, replacing Michel Barnier, who was forced out by an alliance of far-right and -left parties in early December.

This sense of relative calm won’t last - a crowded calendar beckons in the coming days. To highlight a few of the key events:

Tomorrow’s US retail sales report is expected to show the American consumer remaining in rude health. Consensus estimates suggest that headline receipts rose 0.5 percent in November, and the control group—which excludes cars, gas, food, and building materials—might have staged a 0.4-percent rebound after slipping -0.1 percent in the prior month. A hotter-than-expected release could signal a strong handoff into the all-important holiday season, and push yields higher.

Statistics Canada will release its latest inflation report at the same time, with evidence of quiescent price growth likely to help justify last Wednesday’s outsized rate adjustment. The headline consumer price index is seen rising just 0.1 percent on a month-over-month basis in November—down from October’s 0.4-percent print—with the Bank of Canada’s preferred core measures softening slightly, emphasising the restrictiveness of current policy settings. The Bank last week delivered a 50 basis-point cut in last week’s decision, but modified its statement language to say that it would approach future meetings “one decision at a time”.

A softer-than-anticipated print could add to downward pressure on the loonie, but we think losses should be fairly minimal. There has been much rending of garments and gnashing of teeth in the Canadian media over the currency’s decline this year, but from a historical perspective, trading ranges have remained subdued and the downward move has been fairly tame in percentage terms:

The Federal Reserve is widely expected to cut rates by 25 basis points at Wednesday’s meeting, but the decision might come with some hawkish pushback from the likes of Governor Bowman. Growth is running well above the 2-percent full-year forecast submitted in September, job markets have held up surprisingly well, and inflation is showing signs of getting stuck near the top of the central bank’s target range: data released last week showed the main inputs into the Federal Reserve’s preferred inflation indicator—the core personal consumption expenditures index—ratcheting slightly lower, but the headline numbers were consistent with a slower easing in underlying price pressures.

The accompanying messaging could be quite hawkish. A marking-to-market in the “dot plot” summary of economic projections should see median rate expectations ratchet about a quarter point higher across the three-year forecast horizon, essentially subtracting one cut from the four moves previously expected in 2025. Chair Powell could use the post-decision press conference to warn markets against expecting more easing in the months ahead, setting the stage for a pause—or even a halt—in January.

But this should be taken with a Trump-sized grain of salt. The reality is that the president-elect’s policy choices could materially affect economic outcomes next year. The next dot plot, due for release at the Fed’s March meeting, will be far more important in guiding market expectations for 2025 and 2026.

Across the pond, the Bank of England is unlikely to follow suit with its own rate cut on Thursday. Data released a day prior is expected to show headline inflation accelerating in November on a year-over-year basis, rising from October’s 2.3 percent to 2.6 percent, and services cost increases will almost certainly remain far too hot for comfort, holding close to the 5 percent threshold. Officials will likely retain language from the previous statement, which said “a gradual approach to removing monetary policy remains appropriate,” and other communications should be consistent with Governor Bailey’s recent guidance on the trajectory of rate cuts next year - he expects to move just four times, maintaining a pace that would keep rate differentials tilted in the pound’s favour.

The accompanying messaging could be quite hawkish. A marking-to-market in the “dot plot” summary of economic projections should see median rate expectations ratchet about a quarter point higher across the three-year forecast horizon, essentially subtracting one cut from the four moves previously expected in 2025. Chair Powell could use the post-decision press conference to warn markets against expecting more easing in the months ahead, setting the stage for a pause—or even a halt—in January.

But this should be taken with a Trump-sized grain of salt. The reality is that the president-elect’s policy choices could materially affect economic outcomes next year. The next dot plot, due for release at the Fed’s March meeting, will be far more important in guiding market expectations for 2025 and 2026.

A rate hike from the Bank of Japan at Wednesday’s meeting looks unlikely, but isn’t impossible. Markets are assigning less than 20-percent odds to a move after a series of leaks suggested that officials are content with waiting until the early new year before raising borrowing costs, but with growth, wage numbers, and inflation rates pushing higher against a weak currency backdrop, the case for a tightening in policy rates is growing stronger.

On the other side of the world, the Bank of England probably won’t follow through with a rate cut on Thursday. Data released a day prior is expected to show headline inflation accelerating in November on a year-over-year basis, rising from October’s 2.3 percent to 2.6 percent, and services cost increases will almost certainly remain far too hot for comfort, holding close to the 5 percent threshold. Officials will likely retain language from the previous statement, which said “a gradual approach to removing monetary policy remains appropriate,” and other communications should be consistent with Governor Bailey’s recent guidance on the trajectory of rate cuts next year - he expects to move just four times, maintaining a pace that would keep rate differentials tilted in the pound’s favour.

Friday’s US personal income and spending report should not move markets. Economists are fairly united in thinking that the core personal consumption expenditures index decelerated to a 0.13-percent month-over-month pace in November, down from 0.27 percent prior, with base effects lifting the year-over-year print to 2.84 percent from 2.8 percent. And with the Fed’s December decision in the rear-view mirror along with another print due before the January meeting, the implications for monetary policy will be limited.

From a broader perspective, it’s fair to expect typical seasonal dynamics to begin putting downward pressure on the greenback in the weeks ahead. A more hawkish-than-anticipated Fed decision could upset the apple cart—counter-trend funding squeezes have seen the dollar spike higher in previous years—but currency markets are often dominated by mean-reversion trades into year end* as asset managers and hedgers rebalance portfolios.

*Yes, some foreign exchange markets are open on Christmas day. Santa can't buy coffee using US dollars everywhere on earth.

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