The last week saw the pound and euro rally against the US dollar, after markets anticipated the Fed would cut rates earlier and deeper following updated ‘dot plots’ (a graphical representation of the individual Federal Reserve members’ expectations of where interest rates will be at the end of 2024, 2025, 2026 and longer term).

The BoE (Bank of England) and ECB (European Central Bank) then disappointed markets, in that neither followed the Fed’s lead, and instead they were very cautious about cutting next year. The reality is that central banks are still worrying about inflation caused quarters ago, that has very little to do with the current state of the domestic economies, or indeed global macroeconomic conditions. In my view, markets perhaps expected the BoE and ECB to do more than they were prepared to do, but there are plenty of signals from these economies that domestic disinflation, or at the very least stagnation, will become a more pressing problem in 2024.

Indeed, this week has already seen evidence to support that. The December German IFO* business climate index reading reported a weakening in activity. This news, while not a complete surprise, does go against other readings from consumer confidence that seemed to indicate an improvement might be occurring.

I think the risks from this week’s releases from the UK, which include November consumer prices data on Wednesday, November retail sales, and final Q3 GDP (Gross Domestic Product) figures on Friday, are for weaker readings. That’s despite some signs of renewed inflation in parts of UK services/retail. If the UK and Euroland data and surveys do disappoint, that might readjust the interest rate differentials slightly back towards the US, thereby strengthening the USD a bit.

We have seen GBPUSD back away from $1.27 and EURUSD away from $1.10, suggesting that markets are wary of pushing beyond those levels without more widespread supportive evidence. There is also the risk that the US dollar could benefit if data such as the personal income and spending data for November comes in stronger than expected.

Could there also be a sting in the tail for the likes of the JPY and CNY, which have benefited from the broad-based USD weakness of late? Perhaps economic disappointment or another no-show from the Bank of Japan runs that risk for these currencies into the year end?

*Information and Forschung / Germany’s Institute for Economic Research

Last week saw one central bank leave the financial markets with an unpleasant surprise, as the Norges Bank raised interest rates by 25 basis points when the expectation had been for interest rates to be left on hold. That said, the decision was always finely balanced, and the weakness of the Norwegian krone was probably what tipped them over the edge. As for the other central bank meetings, they all went the way they were expected to.

This week, the big meetings include the Bank of Japan, overnight Tuesday, the Hungarian central bank on Tuesday afternoon, the central bank of Colombia early in the evening on Tuesday followed by the Chilean central bank later in the evening. Then People’s Bank of China decide on Wednesday, followed by Indonesia, Turkey and the Czech Republic on Thursday. There are rate cuts expected from Hungary, Colombia, Chile and the Czech Republic, while Turkey is expected to hike. All the other central banks should leave policy on hold, with the Bank of Japan most likely to disappoint markets. 

Currencies in emerging markets could once again prove volatile as liquidity in the markets starts to disappear ahead of the festive break. One large transaction could cause significant unexpected volatility, in my view.