FX Daily: Navigating the Dollar's Uncertain Path
In today's FX market, the dollar's trajectory remains a subject of cautious optimism. Japanese bond yields have rebounded, and US Treasuries and equities are poised for a similar upward trend later in the day. The looming presence of Trump's visit to Davos adds a layer of potential de-escalation regarding the Greenland risk and fears of European asset dumping. As a result, the EUR/USD pair could dip below 1.1700, reflecting these market dynamics.
Authors
USD: Stabilization as a Catalyst for Recovery
Yesterday's dollar sell-off was a multifaceted event, influenced by the volatility spillover from Japanese government bonds (JGBs) and concerns about European investors reducing their Treasury holdings. The impact of JGB volatility on global fixed income was widespread, but the FX response varied. Higher bond yields, even when originating from foreign markets, tend to exert downward pressure on a currency when investors are already sensitive to the country's fiscal health. Over the past year, the USD, GBP, and JPY have demonstrated a negative correlation with their long-term yields (10Y-30Y), making them the three worst-performing G10 currencies yesterday. Interestingly, the GBP underperformed even against high-beta currencies like NOK and NZD, indicating that fiscal factors play a more significant role in FX movements than risk sentiment.
However, we believe that this sell-off is not a compelling reason to chase USD positions. Long-term Japanese bonds have experienced a sharp rebound overnight, reducing a significant source of USD downside risk for the European-US trading session. Meanwhile, S&P500 futures are up 0.4%, while European equities struggle to regain their footing. Greenland's status as a central theme today offers a potential avenue for de-escalation, providing some support to the dollar. Trump's meeting with EU leaders at Davos, coupled with his optimistic remarks, suggests that face-to-face engagement may help ease tensions with the US president.
With no market-moving data releases in the US today, the Fed cut pricing remains unchanged despite the bond and equity sell-off, reinforcing our belief that the dollar faces upside risks amid broader stabilization.
EUR: EUR/USD Below 1.1700?
A brief headline about a Danish pension fund, AkademinerPension, exiting US Treasuries yesterday sparked concerns about a European exodus from US assets. However, the actual size of the fund's holdings in December was relatively small ($100 million). Today, markets are not reacting to these concerns, and if Davos brings geopolitical de-escalation, associated EUR gains may be trimmed. Our perspective is that unless bond volatility spikes again (not our baseline scenario), EUR/USD is likely to fall below 1.1700 during a seasonally strong period for the USD and in light of recent hawkish repricing of front-end USD yields.
In the broader European context, we are cautious about pursuing further rallies in the SEK for now. EUR/SEK is trading at over 2% short-term undervaluation and may be due for an upward correction to 10.80 before re-establishing a medium-term depreciation trend.
GBP: No Surprises in UK Inflation
As discussed in the USD section, sterling's underperformance yesterday was primarily a reflection of the risks associated with importing bond volatility for a currency that has experienced periods of negative correlation with back-end yields due to fiscal concerns. calmer markets this morning suggest that EUR/GBP may face downward pressure and return below 0.870. The UK inflation report for December, released this morning, contains no data likely to significantly impact the February Bank of England meeting. Our UK economist, James Smith, notes that the BoE's preferred gauge of 'core services,' which excludes volatile and indexed items, came in at 4.0% for the third consecutive month. The slight acceleration in headline inflation to 3.4% was partly due to food prices rising to 4.5%. Food prices are closely monitored by MPC members, even though they remain below the BoE's forecast of 5.3%.
CEE: Bearish Bias Persists
While the CEE calendar remains relatively quiet today, with data releases scheduled for tomorrow and Friday, the global narrative continues to dominate the region's attention. Yesterday's US tariff headlines triggered a risk-off environment, causing CEE rates to steepen across the board. However, EUR rates at the front of the curve were heading in the same direction, and the rate differential did not change significantly. The jump in EUR/USD somewhat offsets the risk-off mood, resulting in minimal FX movement. We maintain a bearish bias for the next few days, primarily due to local factors and the pricing of more rate cuts than the global story suggests. Both factors point to weaker FX in the region. Today, attention will remain on global events and Davos talks, but we can expect some defusing of the risk-off mood and market calming, keeping the region stable. The focus is expected to shift back to regional developments in the next few days.
Frantisek Taborsky
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