Downside Risk for EUR/USD Increases

Impact on GBP:

Slowing UK economy presents new risks for Sterling heading into year-end

Keir Starmer's 'shower of gloom' is becoming evident as the CBI and IoD report a weakening UK economy and declining business confidence, which could threaten Sterling's strong performance into 2024.

According to the Confederation of British Industry's (CBI) latest Growth Indicator survey, private sector growth expectations softened in September. Consumer services companies anticipate a "sharp fall" in employment, and private sector firms expect no change in activity over the next three months, marking the end of seven consecutive surveys with positive growth expectations.

The Institute of Directors (IoD) also reported on October 1 that its Economic Confidence Index, measuring business leaders' optimism about the UK economy, dropped further in September to -38, down from -12 in August 2024. This marks the lowest reading since December 2022 (-58).

"The recent data from the UK suggests the BoE may deliver faster and deeper rate cuts, which could reduce the GBP's outperformance seen earlier this year," noted MUFG Bank Ltd.

No Major Data

Impact on EUR:

Returning to $1.1000?

The two-year EUR/USD swap rate continued to widen in favour of the Dollar yesterday, now around -110bp, down 25bp from mid-September's -85bp. The idea that an inflation-wary ECB would ease more cautiously than the Fed is fading, as Powell reiterated no interest in another 50bp cut, while inflation data from Germany, France, Spain, and Italy support the case for an ECB rate cut in October. Even ECB President Christine Lagarde adopted a more dovish stance, expressing greater confidence in disinflation, which will be considered at the October policy meeting.

Eurozone-wide CPI figures are due today, with headline inflation expected to drop below the 2% target to 1.8%, and core inflation to ease from 2.8% to 2.7%. If the ECB holds rates in October, a 50bp cut in December becomes more likely, explaining market pricing of -52bp by year-end and 22bp for this month.

Political risk could add pressure to the Euro, as new French Prime Minister Michel Barnier faces a worse-than-expected deficit and an impending political battle over budget reforms. French bond spreads are unlikely to ease, and Barnier's key Parliamentary address at 3 PM CET today could trigger debt market volatility, affecting the Euro.

Overall, unless there are surprises in EZ or US data, EUR/USD could fall below $1.1100 in the coming days and test $1.1000 if US unemployment remains steady on Friday.

Data: Core CPI Flash Estimate y/y & CPI Flash Estimate y/y: 10am

Impact on USD:

Powell resists calls for a 50bp hike

It’s been a busy start to the week in central bank news and geopolitics: Fed Chair Jerome Powell firmly rejected the possibility of a 50bp rate cut by year-end, while Israel launched a ground offensive in Lebanon. Under different circumstances, such events would have likely strengthened the Dollar, but sensitivity to Fed comments and Middle East tensions has diminished.

On the Fed side, the 50bp cut in September has made market sentiment more dovish, perhaps due to the belief that the Fed wouldn’t want to underdeliver on easing if a 50bp move were expected by the FOMC meeting. Powell provided unusually specific guidance on Monday, stating the base case is for two 25bp cuts by year-end, indicating his disagreement with the market's dovish outlook. Despite this, the Fed Funds Futures curve is pricing in 70bp of cuts by December, suggesting that markets expect weak data to push the Fed into another surprise cut, skewing near-term risks toward a stronger Dollar.

The connection between geopolitics and FX markets also remains weak. Israel's ground raids in Lebanon were anticipated by U.S. authorities, and the escalation was largely expected. With oil prices remaining low and no major impact on commodities, FX markets have not reacted significantly to the developments, presenting additional upside potential for the Dollar.

On the data front, today’s August JOLTS job openings report is expected to show an unchanged figure of 7.673 million after a surprise drop last month. Markets may react more strongly to the job openings data than to the ISM Manufacturing Index, which is projected to stabilise around 47.5.

Data: ISM Manufacturing PMI & JOLTS Job Openings: 3pm

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