The imbalance in the policy rhetoric of the Fed and the ECB continues to widen, only this time the ECB is more hawkish, which cannot but prop up EURUSD. After a week of doubts, the pair tried to renew the rally pushing through the 1.09 level. However, later during the London session, the dollar began to recover, the breakdown of the lower limit of the short-term range in DXY (the level of 102) in the absence of fundamental grounds triggered strong USD bids:
The Fed will hold a meeting next week, given how much the dollar has lost recently, shorting the dollar before a possible surprise is most likely an unpopular tactic now, which also explains why the dollar is actively bid below the 102 level.
Trading volume and liquidity in the markets declined markedly as China began a week of public holidays in connection with the Lunar New Year. Risk assets have generally risen well since the start of the year, with European and Chinese equities leading the pack, gaining 8%. Bond markets also performed well, with emerging markets’ sovereign debt leading the way.
Ahead of the Fed meeting, attention will be focused on the preliminary January PMI figures for both manufacturing and services’ sectors which are expected to remain at pre-recession levels below 50. On Thursday, a fairly strong 4Q22 US GDP of 2%+ should appear, although the impact on the market may be small if the cyclical component (fluctuations in imports) will be the main contributor to the positive change. On Friday, personal income data for December will be released, including the Fed’s preferred measure of inflation, the PCE core deflator.
Judging by the 2-year euro swap levels (3.19%), European Central Bank speakers managed to refute a Bloomberg News report published last Tuesday that the ECB wanted to slow down the pace of tightening after February. This story led to a contraction in the swap rate to 3.05%, which led to a weakening of the EUR/USD. Both of these trends are now being reversed. However, as with the dollar above, investors are unlikely to consider bullish targets at 1.0950/1.1000 ahead of Fed risks next week.
As for the data on the eurozone, it is worth paying attention to the preliminary estimates of the PMI index for January in the eurozone, Germany and France (to be published tomorrow) and the German IFO on Wednesday. Any further comments on a new joint EU bond issue to support green investment could also be a bullish sign for the euro, as European politicians try to prop up local industries in response to President Biden’s inflation-lowering bill.
Sterling continues to perform well and maintains the gains made last week thanks to strong wages and consumer price fundamentals. Now the market is counting on a 50 basis point rate hike by the Bank of England at the meeting next week. There has also been a marked improvement in the UK sovereign risk perception, as evidenced by the five-year sovereign CDS trading up to 22 basis points last week.
The UK calendar this week is mainly focused on the January PMI, where both the manufacturing component and the services sector are expected to be in recession territory. GBP/USD may postpone a breakout above 1.2450/2500 this week and prefer to wait for the policy update from the Fed.