G10 FX Weekly: USD to Lead the Way Into Q4 After Central Bank Deluge
- By Richard Jones
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- 5 min read
Summary
- September has been a busy month for G10 central banks, with FX price action swiftly reacting to the new global monetary policy landscape.
- FX markets are set for a lively Q4, with leaders and laggards emerging as most central banks near the end of their respective tightening cycles.
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Summary
- September has been a busy month for G10 central banks, with FX price action swiftly reacting to the new global monetary policy landscape.
- FX markets are set for a lively Q4, with leaders and laggards emerging as most central banks near the end of their respective tightening cycles.
Market Implications
- The US dollar should continue its recent strong run into Q4, leading the G10 currencies in the coming weeks.
- The euro will be mixed into Q4, with the shared currency set to struggle against the dollar and rally against the pound and Swiss franc.
- We are neutral the Japanese yen. Weakness will probably persist in the very near term, raising the threat of Japanese intervention to strengthen the yen.
- After setting the G10 pace all year, the Swiss franc is overdue a retracement lower in the coming months.
- The pound is our least favourite G10 currency, and we see it lagging its peers in Q4 2023.
Introduction
Central banks across the G10 – including the US Federal Reserve (Fed), the European Central Bank (ECB), the Bank of Japan (BoJ), Bank of England (BoE) and Swiss National Bank (SNB) – all updated their monetary policy stances this month.
While many decisions followed consensus expectations, some surprises saw reactive price action across G10 FX. Heading into Q4, we see some clear patterns emerging.
The USD goes into Q4 as the clear pacesetter and will remain so in the coming weeks.
We think the euro will be mixed, the yen will be subject to whipsaw price action, the Swiss franc is set to retrace some of its strong 2023 performance in Q4, and that the pound will be a strong laggard into yearend.
Latest Updates From the Major Central Banks
After a choppy, illiquid July and August, dominated by rangebound price action in most G10 currencies, activity rose in September after a flurry of central bank rate announcements. We examine the main ones.
US Federal Reserve
The Fed announced its latest policy decision on 20 September, keeping the target for its policy rate on hold at 5.25-5.50%. This was as the market expected going into the meeting.
Since then, market pricing for the Fed has not changed materially. By yearend, the market prices a 40% probability of another 25bp Fed rate rise. By end-2024, the market sees the Fed’s policy rate at ~4.67%, about 65bp lower than now.
European Central Bank
The ECB announced its latest policy decision on 14 September, partially surprising the market by hiking the deposit rate 25bp to 4%.
It was a partial surprise because the market only priced ~16bp of tightening on the eve of the ECB announcement. In the week or two preceding the decision, the market priced a very low probability of an ECB rate hike, something we highlighted on 4 September.
The market then began to price a more hawkish outcome, although the ~65% probability of a hike heading into the meeting was far from a certainty.
Since then, market pricing for the ECB leans toward September’s rate hike being the last of this tightening cycle. By yearend, the market prices a ~17% probability of another 25bp rate rise. By this time next year, the market sees the ECB policy rate ~40bp lower than now.
Bank of Japan
The BoJ, as expected, kept its monetary policy unchanged on 22 September. The market had priced less than 1bp of tightening, and the BoJ’s policy rate remains at -0.10%, by far the lowest in the G10.
My Macro Hive colleague Bilal Hafeez notes the BoJ ‘disappointed the hawks,’ delivering a more dovish appraisal than at the previous rate announcement in July.
Since the rate announcement last week, the market still prices tighter policy from the BoJ. By yearend, there is a ~65% probability of a 10bp rate hike, with a cumulative expectation of ~23bp of BoJ tightening expected by this time next year.
Bank of England
The BoE left its policy rate unchanged at 5.25% on 21 September, partially surprising a market that had priced the probability of a 25bp rate hike at ~50%.
Unlike ECB pricing, BoE pricing tacked dovishly in the days preceding the rate decision. The day before the announcement, the market priced an ~80% probability of a 25bp rate rise. On 1 September, it was ~90%.
The market still prices a strong chance that the BoE will raise rates again, with the probability of another 25bp rate hike peaking at the February 2024 meeting at 76%.
Swiss National Bank
On 21 September, the SNB kept its policy rate unchanged at 1.75%, partially surprising the market, which had priced a ~68% probability of a 25bp hike.
The SNB keeping rates on hold was a particular surprise as they had almost always matched the ECB’s moves this cycle. With the ECB raising rates the week before, the SNB pause bucked that trend.
The SNB also softened its language on FX interventions to support the CHF. Currency interventions have been an important tool for Swiss authorities to keep domestic inflation in check, and the softening language means they will probably less aggressively buoy the CHF than in recent months.
Our Q4 Prognosis for the G10 Majors
Into Q4, the G10 leaders and laggards are as follows:
US Dollar
The US Dollar Index (DXY) has risen for 10 consecutive weeks, its longest winning streak since 2014. Since the week ending 14 July, the DXY has gained 5.8% and currently trades at a six-month high (Chart 1).
The gains have been broad-based, with the dollar gaining against all its G10 counterparts. We expect this to continue in coming weeks.
As we wrote on 14 September, the current USD rally has additional momentum and will probably rally into 4Q. The broad-based nature of the rise, together with US economic outperformance and higher USD yields, will act as a tailwind.
At some stage, we think the USD rally will be worth selling into because it cannot last indefinitely, and a correction is inevitable. This will require patience – it is too soon to fade USD strength.
Euro
We see a mixed prognosis for the euro.
Against the dollar, the euro has fallen for 10 straight weeks and is poised to extend this winning run to 11 weeks. EUR/USD has reached our first downside target of 1.05 and, while we think some further depreciation in the pair is likely, we are wary that we will now see more two-way risk in EUR/USD (Chart 2). We will therefore now proceed cautiously and look to slowly reduce position sizing at the current level.
We expect the euro to rally against the pound, however. EUR/GBP has rallied four of the past five weeks, and we expect that streak to continue given our bearish view of GBP (more on this below).
We also expect a corrective rally in EUR/CHF, with the pair set to return towards parity in Q4.
Japanese Yen
The Japanese yen is by far the weakest G10 currency in 2023, down almost 12% versus the US dollar so far this year and falling against all its G10 counterparts.
We are currently neutral on the yen. On the one hand, the BoJ left its monetary policy unchanged last week and adopted a more dovish stance than in July, which would argue for additional JPY weakness. On the other hand, JPY weakness will likely prompt official Japanese intervention.
Last week, a senior official at the Japanese ministry of finance (MoF) warned that the MoF is in close contact with US officials. Moreover, US Treasury Secretary Janet Yellen said FX intervention by Japan would be understandable. This sets alarm bells ringing for us.
Notably, when the MoF most recently intervened in the currency markets in October last year, USD/JPY fell from a peak just below 152 to 136 in about six weeks (Chart 3).
That does not guarantee a similar reaction should the MoF intervene soon. However, given the current levels in many JPY pairs, we are wary of another round of yen buying by the MoF and therefore stand aside.
Pound Sterling
Of all the G10 currencies, we are most bearish on sterling.
Last month, following the BoE rate hike on 3 August, we argued UK yields and the pound would fall. Pricing of BoE expectations was far too bearish then. We correctly expected it to unwind, and GBP is since down about 1.5% on a trade-weighted basis. We expect further downside for the pound and UK yields.
As our colleague Henry Occleston wrote, the BoE’s pause last week is more dovish than the market is pricing. We agree with Henry – the BoE has probably finished hiking.
With its most recent commentary, Henry suggests the MPC has laid the groundwork for a very dovish November MPR. This adds to our conviction that there is room for the market to price out any more tightening and shift to pricing cuts.
This will weigh on sterling. We expect cable to trade back towards its YTD low near 1.18 and EUR/GBP to trade back towards 0.9000 in Q4 (Charts 4 and 5).
Swiss Franc
The Swiss franc is the strongest G10 currency in 2023, one of only three currencies to trade higher against the USD this year.
Swiss franc strength has been particularly impressive given that the typical driver of CHF appreciation – a flight to safety based on geopolitical tensions and/or severe global economic distress – has been largely absent this year.
Nonetheless, despite this impressive performance YTD, the franc is probably overdue a downside correction. We made the case for CHF underperformance into yearend in our piece last week.