FX Daily: The Elusive Dollar Decline
The US dollar's dominance faces a challenge as economic data and market dynamics suggest a prolonged period of de-dollarization. Despite recent positive US economic indicators, the dollar's strength remains resilient, with no significant impact from the ongoing debate surrounding Powell's Fed leadership.
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USD: A Stable Currency
The US dollar's steady rise this week can be attributed to robust economic data, including strong retail sales and jobless claims. The Fed's Beige Book indicates a mild economic expansion without immediate threats to employment. Investors have responded by adjusting their expectations, pushing the Fed's terminal rate for the easing cycle 5bp higher, resulting in a 32bp re-rating from October lows. Consequently, the DXY index is gradually climbing with low volatility.
The release of US Treasury TIC data for November highlights a significant trend: foreign investors continue to invest heavily in US assets. While the TIC data is volatile, the 12-month average reveals a substantial net foreign purchase of US assets, averaging around $100bn per month in November, compared to $25bn in the summer of 2024. Equities attracted a substantial portion of these inflows, with 45% of the private sector's large inflow directed towards equities, and even the foreign official sector purchased $23bn worth of equities. Despite the BRICS official group's continued sale of Treasuries, private sector investments overshadow these transactions.
In summary, the de-dollarization process is expected to take time, and a significant decline in the dollar's value this year will depend on lower US interest rates and increased foreign hedging of US assets.
The market's calm on this Friday is notable, as the US Treasury's support for potential interventions to sell USD/JPY and USD/KRW near 160 and 1500, respectively, could impact the dollar's trajectory. If these interventions occur, the DXY index might continue its ascent towards 100.
EUR: Carry Trade Funding Currency
The EUR/USD currency pair's one-month traded volatility hovers around 5%, indicating a range-bound trend in the near term. With low volatility and high-yield currencies in demand, investors prefer funding carry trades using the euro, which costs just 2.00% (based on one-month implied yield), compared to 3.55% for the dollar. This approach is perceived as less risky than funding carry trades using the yen, where USD/JPY volatility is 8.5%, and the Bank of Japan could intervene at any time, potentially causing a brief 2-3% decline in USD/JPY.
The eurozone's data calendar is sparse, and EUR/USD may drift towards 1.1555/65 without attracting much attention.
JPY: Political Uncertainty and Interventions
Predicting the direction of USD/JPY is challenging due to the upcoming dissolution of the Japanese lower house and a snap election on February 8th. The LDP's success is expected to influence the yen's value, as looser fiscal and monetary policies are favored. A significant improvement for the LDP would be a 34-seat gain, securing a simple majority. However, Japanese politics have surprised in the past, and the opposition's unity could hinder the LDP's success.
The threat of FX intervention adds complexity to the situation. A proposed joint intervention by the Fed and BoJ to sell USD/JPY could be a game-changer, indicating a volatile USD/JPY market in the coming month. Despite the 8.5% one-month traded volatility, it is considered a reasonable value.
PLN: Continuing Cutting Cycle
The National Bank of Poland's press conference yesterday confirmed the continuation of the cutting cycle, despite unchanged rates on Wednesday. The governor left the February meeting open, allowing for a potential longer pause until April. This flexibility opens up various scenarios, and the timing of individual rate cuts remains uncertain.
The terminal rate could reach 3.50%, but a lower number cannot be ruled out. The overall outlook remains unchanged, with inflation supporting further rate cuts, but the labor market and wage developments will be closely monitored. The economists' forecast predicts three more rate cuts in March, May, and September, ending the cutting cycle at 3.25%.
The market reacted dovishly to the press conference, reversing the previous hawkish stance. The terminal rate was slightly lowered by 2bp to 3.41%, and a return to previous lows near 3.30% is expected. The PLN is anticipated to weaken as liquidity returns to the market, with the market testing 4.220 due to the NBP's recent message.
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