Rising Geopolitical Tensions Will Likely Limit Any Rebound Potential for the Single Currency

Markets

This week’s consolidation pattern on bond markets simply continued yesterday. Lower weekly jobless claims (213k) and a disappointing November Philly Fed Business outlook balanced each other out data wise. US yields added 3.3 bps (2-yr) to 0.4 bps (30-yr) in another small bear flattening move with money markets reducing the likelihood of a December 25 bps rate cut to 55%. Our base scenario remains that the Fed will go ahead with a rate cut. If data permit, they can skip in January, allowing the FOMC to get a better view on the interplay with a likely stimulating fiscal policy under president-elect Trump by the time of new growth and inflation forecasts in March. German yields dropped by 1.1 bp to 3.6 bps with the belly of the curve outperforming the wings. The (European) proximity to this week’s escalating war between Russia and Ukraine directs some haven flows into Bunds. European stock markets eventually managed to recover from early losses induced by talk that Russia launched a first ever intermediate-range ballistic missile. The euro extends its losses, with EUR/USD giving up 1.05 against an overall strong USD. The pair is on track to test the 2023-2024 sideways range bottom at 1.0448. The trade-weighted dollar is equally inches away from the 2023 high at 107.35. Only the Japanese yen manages to more or less keep pace with the greenback in such conditions, changing hands at USD/JPY 155.

Today’s eco calendar contains November global PMI’s. Rising geopolitical tensions will likely limit any rebound potential for the single currency going into the weekend even in case of firmer European numbers. Consensus expects a stabilization at the 50 breakeven level for the EMU composite gauge. Anything bar a huge negative surprise will also convince final traders out of there 50 bps December rate cut bets by the ECB (15% probability) as all other intermeeting data (Q3 GDP, October CPI & PMI, Q3 wages) all surprised on the upside. In the US, asymmetric risks are on the other side given that we think markets are underestimating the likelihood of a Fed December move.

News & Views

Japanese inflation eased but remained above the Bank of Japan’s 2% target in October. Headline price increases decelerated from 2.5% to 2.3% and the gauge excluding fresh food (the BoJ’s preferred gauge) came in at 2.3% as well. The latter was down from 2.4% but above 2.2% expectations. Core CPI (ex. fresh food and energy) picked up from 2.1% to 2.3%, suggesting energy was a key factor behind the slight slowdown. Utility subsidies indeed shaved off about 0.5 ppts of the overall index. Service prices gained momentum, quickening from 1.3% to 1.5%, adding to evidence that consumer-led inflation is becoming more entrenched in the economy. That should bring comfort to the Bank of Japan, which is looking for signs its (underlying) inflation outlook is materializing, a key condition to further normalize its monetary policy. The next December meeting is a live one with money markets slightly in favour (56%) of a 25 bps rate hike to 0.5%. The Japanese yen fails to profit this morning against an overall stronger USD. USD/JPY hovers just south of 155. This level serves as a short-term equilibrium level since the dollar (and rate) rally stalled and geopolitical risk-off kicked in, supporting JPY.

UK consumers turned a bit less sour in November. The GfK confidence index edged up from -21 to -18, defying forecasts for a further drop to -22. GfK said that nervousness ahead of the first Labour budget and US elections appear to have passed. The survey was taken between October 30 and November 15. Consumers felt some relieve that Labour’s planned tax increases mostly fell on businesses rather than individuals. All components posted improvements with the biggest taking place in the perceived climate for major purchases (-21 to -16). Consumer’s personal finances as well as the economic situation, both over the past and next 12 months, all gained from the previous month too. GfK does note that consumers still feel acute cost-of-living pressures and urged the government to deliver on their promises to tackle the matter.