December 2023 Review & Themes

Pound

After a barnstorming November for the pound, December saw sterling eke out more gains against the dollar, but give up almost all of its territory versus the euro.

In the week after Christmas, GBP/USD hit a five-month high, topping 1.2827 for the first time since the first day of August. This marked a jump from 1.25 before the unexpectedly dovish Federal Reserve statement on 13 December, which was closely followed by the Bank of England taking the opposite tack, putting the wind firmly behind Cable.

The BoE’s monetary policy committee held rates at 5.25% again, with six of the nine members in favour of this decision and the statement adding that monetary policy would “need to be sufficiently restrictive for sufficiently long”. This did not provide the equivalent nod to rate cuts as the Fed had provided. Governor Andrew Bailey also pushed back on market expectations, saying that “we are more cautious because we need to see those more persistent elements of inflation, which we see in things like services prices, turn in the right direction quite decisively”. This created “the perfect storm” for GBP/USD, forex analysts at UBS said.

However, Cable slipped back after inflation data on 20 December fell much more than expected. CPI in the UK has been notably higher than both the US and the eurozone, which is why BoE policymakers are sticking to the hawkish script, said Rabobank FX strategist Jane Foley, noting that three members of the MPC continue to vote for rate hikes. “The market appeared to be fairly accepting of the view that BoE rate cuts in 2024 would lag those of both the ECB and the Fed,” Foley stated, adding that this was reflected in the pound’s outperformance of both USD and EUR since the start of November. However, the softer UK inflation data has challenged this, she said, resulting in the market pricing in more BoE rate cuts.

As for EUR/GBP, the month started with the pound on the front foot, falling below 0.856 for the first time in about three months before the week of big central bank meetings flipped the momentum and drove EUR up to press its nose up against 0.870 in the last week of the year.

In other notable currency pairs, GBP lost over 3% against CHF, JPY and the Scandi pairs, with falls of more than 2% versus the Down Under dollars.

Euro

It was a more balanced month for the single currency, which bounced back against the pound (with the smallest annual range since 2006) and US dollar, as well as the currencies of China and European peripheral nations. However, it sank more than 3% versus NOK and JPY, over 2% against SEK and CHF, and 1%-plus on the AUD and NZD.

Over the past three months, EUR/USD has risen from 1.05 towards 1.10, prompted by several factors, according to analysts, led by oil prices declining, which typically supports the more energy import-dependent eurozone over the US. "The drop led policymakers to lower their inflation outlooks for both the US and Europe”, said UBS strategist Thomas Flury. "This, in turn, allowed the Fed and the ECB to adopt a less hawkish stance at their December meetings, in which neither pushed back too strongly against market expectations for rate cuts next year.”

The ECB kept rates on hold as widely expected but, similarly to the BoE, didn’t echo the more dovish stance from the Fed. President Christine Lagarde said “we should absolutely not lower our guard” and that “we did not discuss rate cuts at all”, but there was an acknowledgement of the better picture for inflation, dropping wording from previous statements that inflation was set “to stay too high for too long” and cutting forecasts for CPI to fall to 2.7% in 2024 from 3.2% in September.

Deutsche Bank said the hawkish tilt of the meeting was “reducing the risk of the ECB cutting as soon as March, but retain their view of rate cuts starting in April”, while economists at ING said: “unlike officials at the Fed, ECB members have managed to deliver a more coordinated pushback on rate cuts, both at last week’s policy meeting and in post-meeting communication. Despite that, it still appears quite hard to dissuade the market from its conviction that rates will start to be cut in April.”

Dollar

The greenback was glowing red in the face of pretty much every major currency pair after the Fed’s surprisingly dovish turn.

The mid-month meeting saw most officials predict the Fed Funds Rate will fall from the current 5.5% to around 4.4-4.9% by the end of 2024, with a small majority predicting there will be three quarter-point rate cuts in the coming year. What’s more, Fed chief Jerome Powell initially decided not to push back against market expectations of early and significant cuts for 2024.

GBP/USD rose almost 1% over the month, EUR/USD by over 1.2%, while the Aussie gained over 3%, NOK over 6% and JPY continued its fightback, up over 4% to levels seen at the start of August.

The reason is, in part, that traders and futures markets have grown even more confident about the chances of rate cuts from the Fed in 2024, with CME’s FedWatch tool suggesting the majority are predicting rates to be between 3.5% and 4.0% in December next year.

Deutsche analyst Jim Reid noted that this is equivalent to at least six 25bp rate cuts next year, “which is normally the sort of pace you see around a recession”, and is a more aggressive pace than the Fed indicated at its latest meeting. “There’s a clear divergence between the Fed’s own signals and market pricing, which has remained even as several officials have actively pushed back on the reaction”.

January Key Risk Events & Themes

Pound

Will the market get a grip on reality? Optimism is generally a good thing, though blind optimism often brings disappointment. This is the problem facing the currency markets in the new year. As explained by analysts at Rabobank, market-implied policy rates have 125 basis points chopped from the UK bank rate by the end of 2024. There is little to justify this optimism and “it is very likely that the BoE will attempt to temper these expectations”. Slower inflation is the root cause of the market’s optimism, so the January 17 data read will be of utmost importance in setting the market tone going forward.

Eyes on house prices: housing affordability emerged as a crisis point for the UK economy in 2023. House prices dipped 1.8% over the year, according to Nationwide, but mortgage rates ran hot and deposit requirements remained elevated. What happens now? According to Robert Gardner, Nationwide’s chief economist: “a rapid rebound in activity or house prices in 2024 appears unlikely. While cost-of-living pressures are easing, with the rate of inflation now running below the rate of average wage growth, consumer confidence remains weak and surveyors continue to report subdued levels of new buyer enquiries.”

Euro

Euro range-bound in January: most analysts reckon the euro will be range-bound in the opening stages of 2024 before a potential breakout. UBS analysts summed it up in a recent research note: “there is little optimism for the euro, given subdued growth in the Eurozone and ongoing geopolitical risks. As a result, the upside for the euro is limited, while the downside for EUR/USD is limited by the Fed’s need to ease monetary conditions next year. EUR-based investors can look for range strategies versus the USD.”

Oil prices: lower oil prices benefitted the import-dependent eurozone in the last quarter of 2023. Despite the prevalence of geopolitical conflicts and OPEC+ production cuts, Brent crude oil fell by $10 per barrel over the past three months, alleviating some inflationary pressures for the single market. Theoretically, lower oil prices should be bearish for the euro, as it could galvanise the dovish faction of the ECB, but analysts say to expect oil price volatility going forward. “The overall theme of the year though seems to indicate that heat has come out of the price for now – but that can change at very short notice,” said Sophie Lund-Yates at Hargreaves Lansdown. US EIA inventories have weighed down the price of crude, so checking these numbers on the US economic calendar would be a wise decision in the months to come.

Dollar

Fed to rein in market optimism: just like the Bank of England, the US Federal Reserve needs to engineer a bit of scepticism in the market in relation to interest rate cuts in the new year. Though it’s undoubtedly a positive thing (for the Americans) that the US economy has outperformed other developed nations, this also lends credence to a higher-for-longer rates situation. Rabobank analysts believe that no more than three 25-basis-point rate cuts should be expected by the end of 2024, “rather than the five or so moves that the market is anticipating”. Regardless of the definitive number, general consensus contends that none of these cuts will be on the agenda when the Federal Open Market Committee meets on 31 January.

Near-term upside: with the US economy broadly outperforming and a higher-for-longer rates situation on the menu, near-term dollar upside is the most obvious forecast to make. Ipek Ozkardeskaya at Swissquote said she “wouldn’t be surprised to see the US dollar recover against most majors in the first weeks of 2024”, while UBS analysts expect the dollar to remain buoyant in the near term before gravitating lower in the second half of 2024.

Jobs data and inflation in focus: inflation data will be a primary determiner of dollar strength or weakness. The Fed is only 110 basis points off its 2% year-on-year inflation target; the December print expected on 11 January will let us know if this trend has continued. If inflation softens further, it will increase the market expectations for rate cuts, thus sending the dollar lower, and vice versa. Will inflation fall? Oil prices are certainly down, while shipping route disruptions are not expected to significantly burden consumer goods prices. The biggest inflationary risk may be the resilient labour market. November data shows a persistently low unemployment rate, though continuing jobless claims continue to rise and new job openings have decreased. Non-farm payrolls and the latest unemployment figures will be closely watched on 5 January.

KEY DATES IN JANUARY

United Kingdom

• January 5: Halifax house price index YoY; New car sales
• January 9: Retail sales monitor
• January 12: GDP YoY; Balance of trade; Construction output YoY; Industrial production YoY; Manufacturing production YoY
• January 16: Unemployment rate
• January 17: Inflation rate YoY; PPI; Retail price index YoY
• January 18: RICS house price balance
• January 19: Retail sales YoY
• January 26: GfK consumer confidence
• January 30: Mortgage approvals

Eurozone

• January 2: HCOB manufacturing PMI (44.2 exp)
• January 4: HCOB services PMI (48.1 exp); HCOB composite PMI (47)
• January 5: HCOB construction PMI; PPI YoY
• January 8: Economic sentiment; Retail sales YoY
• January 9: Unemployment rate
• January 15: Balance of trade; Industrial production YoY
• January 16: Consumer inflation expectations
• January 17: Inflation rate YoY
• January 25: European Central Bank interest rate decision

United States

• January 3: JOLTS job openings; Federal Open Market Committee minutes
• January 4: Challenger job cuts; Initial jobless claims (215,000 exp)
• January 5: Non-farm payrolls (163,000 exp); Unemployment rate (3.8% exp)
• January 8: Consumer inflation expectations
• January 9: Balance of trade
• January 11: Inflation rate YoY; CPI
• January 12: PPI YoY
• January 17: Retail sales YoY; Industrial production YoY; Manufacturing production YoY
• January 30: JOTS job openings
• January 31: Federal Reserve interest rate call (exp hold at 5.5%)

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