Are the Bears in Control of EURUSD?

As we step into 2024, the USD is making a comeback, thanks to investors recalibrating their expectations for aggressive Fed rate cuts. This shift is pivotal, and if upcoming US data nudges investors to reconsider their dovish Fed outlook, we anticipate further USD gains. Notably, the recent USD underperformance against the EUR contrasts sharply with the USD-EUR relative rate spread, indicating market expectations of the ECB being more dovish than the Fed in the coming months. The divergence between the Fed and ECB, underscored by incoming data from the US and Europe, might pose challenges for EUR/USD.

Analysing the FX market, EUR/USD continues to trade at a premium relative to the EUR-USD rate spread. Downside surprises from US labour data and upside surprises from European inflation may be necessary for the currency pair to regain ground. The USD, considered a buy-on-dips across the board, remains strong as global investors reevaluate their dovish Fed stance. Conversely, the EUR might be a sell-on-rallies, given that any inflation reacceleration could fuel Eurozone stagflation fears and impact the EUR adversely.

GBP Outlook - Keeping an Eye on a Bullish Scenario

In the past month, the GBP reaped minimal benefits from USD struggles, aligning with UK money markets adjusting BoE easing expectations. EUR/GBP reached 0.87 at the close of last year and has since hovered just below this level in 2024. There is potential for EUR/GBP to revisit lows of around 0.85 in the months ahead, as the UK economy might withstand challenges better than anticipated. Encouraging signs from last month's UK flash PMI readings, particularly the services index rising to a six-month high of 52.7, suggest resilience. Today's final print may affirm this, marking a notable divergence from the deteriorating Eurozone equivalent since Q122. Additionally, the absence of warning signals in the latest BoE credit figures could further support the GBP.

Navigating AUD/USD in the Face of Changing Dynamics

The driving forces behind AUD/USD currently involve commodity prices and the Australian-US short-term rates spread. Notably, iron ore prices surged to a three-year high at the end of the year due to hopes for significant measures in China's property market. President Xi Jinping's commitment to economic recovery further fuelled speculation. However, our China economist anticipates a slowdown in China's growth from 5.2% in 2023 to 4.4% in 2024, affecting the AUD/USD rally. The dip in the Australian-US short-term rate spread, influenced by FOMC minutes, may lead to near-term pullback, but we project a rebound in 2024.

While the market may be overestimating Fed rate cuts for 2024, the RBA's stance, potentially holding or cutting rates later in the year, will contribute to AUD/USD dynamics. Australian inflation data for Q4, released on January 31, becomes crucial. Factors like Cyclone Jasper and flooding impacting food prices in Queensland, coupled with falling petrol prices, make forecasting challenging. Yet, risks persist of the data surprising the RBA positively and triggering a rate hike.

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