This article is a rewritten and expanded version of the original “FX Weekly – 24 October 2023” published by MUFG Research. All insights and analysis are attributed to MUFG’s currency strategy team.
Foreign Exchange Weekly Update – Market Trends as of October 24, 2023
Author: MUFG Research
Overview:
The global foreign exchange markets remain driven by an evolving mix of macroeconomic indicators, central bank guidance, and geopolitical undercurrents. As inflation pressures persist and monetary policy divergence becomes more pronounced, traders and investors are monitoring central bank signals and interest rate expectations with increased intensity.
Recent market activity has been shaped by the mounting uncertainty over global growth prospects, continued resilience in the United States economy, rate decisions from major central banks including the Federal Reserve and the European Central Bank (ECB), and developments in key geopolitical hotspots across the globe.
The following sections offer an in-depth breakdown of recent FX trends, central bank policy expectations, and currency performance.
Key Macro Developments Driving FX Markets
– Global GDP forecasts have been gradually revised lower due to sluggish activity in China and increasing signs of cooling in the eurozone and UK.
– However, the United States has continued to show exceptional economic resilience, with strong labor market data, robust consumption, and improving business investment.
– The divergence in economic performance is translating into equally divergent monetary policies, with consequences for currency values around the world.
U.S. Dollar: Defensive Positioning and Rate Path Uncertainty
The U.S. dollar (USD) has remained supported over the past week, and while gains have slowed due to mixed economic data and softer inflation trends, the greenback continues to benefit from a relatively resilient domestic economy.
– The Federal Reserve is widely expected to hold interest rates at the current level in its upcoming meeting after its previous 25 bps hike in July.
– Fed officials, however, have signaled that interest rates may stay elevated for a longer period, maintaining a restrictive stance to ensure that inflation returns to the 2% target.
– The recent pullback in Treasury yields from their peaks has slightly reduced upward pressure on USD, but safe-haven flows and the carry advantage keep the dollar broadly supported across G10 currencies.
Factors reinforcing USD strength:
– Continued economic resilience in the U.S. compared to Europe and Asia.
– Hawkish commentary from Fed officials around rates staying higher-for-longer.
– Increased risk aversion due to geopolitical concerns, including tensions in the Middle East.
– A historically strong correlation between USD and global risk aversion episodes.
Looking ahead, the MUFG strategists believe that the U.S. dollar might face moderate downside pressure if signs of U.S. economic slowdown become more evident or if Fed officials start to more openly acknowledge disinflation trends. However, for now, the broader market bias remains USD-positive.
Euro: Weaker Fundamentals Continue to Challenge the Common Currency
The euro (EUR) continues to face downside risks as economic activity in the eurozone shows persistent signs of weakness.
– Flash PMI data for October indicated that eurozone economic activity is likely contracting in the fourth quarter, with the composite PMI falling to 46.5, below the neutral 50-mark.
– Germany in particular continues to underperform, reflecting industrial sector weakness and declining demand from key export markets.
– The European Central Bank (ECB), ahead of its meeting this week, is widely expected to hold rates steady, having raised them 10 times in a row since 2022.
ECB policy outlook:
– MUFG analysts believe that the ECB has completed its hiking cycle, with the market also pricing in rate cuts gradually starting in the second half of 2024.
– Inflation data in the eurozone remains relatively high, but forward-looking indicators suggest it will moderate in coming months, reducing the urgency for further tightening.
Implications for EUR:
– The euro has struggled to maintain levels above 1.06 against the USD.
– A dovish ECB stance, relative to the Fed’s more
Explore this further here: USD/JPY trading.