US Dollar Downside Risks Persist

Summary:

The U.S. dollar remains vulnerable despite a brief rebound, with USD/JPY pressured by Japan’s hawkish shift and EUR/USD watching Ukraine–Russia talks. Soft data and dovish Fed expectations keep downside risks intact.

We think the conditions for US Dollar weakening persist after yesterday’s rollercoaster ride. USD/JPY remains particularly vulnerable after the BoJ’s seemingly hawkish turn, while EUR/USD is awaiting some hints from crucial Ukraine-Russia peace negotiations

USD: Still Vulnerable

The dollar came under pressure yesterday during European hours but recovered during New York’s session, potentially thanks to some safe-haven flows abandoning high-beta currencies. Admittedly, the current market environment – bonds and risky assets both falling – isn’t giving clear-cut indications for FX. Some risk stabilisation is likely needed to bring the dollar lower, which remains our call for this week.

As discussed recently, the dollar remains expensive relative to its short-term rate differentials across most of the G10. Yesterday’s ISM manufacturing didn’t move pricing for a December cut as expected: prices paid were a bit higher than expected, but the headline index print was soft. We expect that the remainder of the week will validate the market’s dovish pricing for next week’s Fed meeting.

Part of yesterday’s market instability was driven by a bond market selloff in Japan following hawkish comments by BoJ Governor Kazuo Ueda. After yesterday’s spike in 10-year JGBs yields by around 6bp, this morning we see some calming and a decline of almost 3bp from the highs, and pricing for a December hike is 20bp.

USD/JPY briefly traded below 155.0 yesterday before the USD rebound: we think conditions for a new break lower this week are all there unless we hear some softening of the hawkish tone by Ueda or other officials.

EUR: Cool CPI Not a Game-Changer

Developments in the Russia-Ukraine peace talks remain the most relevant topic for the euro this week. As US Special Envoy Steve Witkoff meets with President Putin today, we should gain a clearer sense of how close we are to any agreement.

On the macro side, today’s CPI shouldn’t move the needle dramatically for ECB rate expectations. However, we expect this flash November estimate to show headline CPI slowing from 2.1% to 2.0% and core CPI from 2.4% to 2.3%, which are both 0.1 percentage points below consensus. If anything, the risks are slightly on the downside for the euro, but our expectation is for a neutral FX impact nonetheless and EUR/USD can eye 1.170 again soon if USD drops in line with our call.

Source: investing

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