FX Weekly: Consumer sentiment rises for the holiday season

US Federal Reserve
Market bias: Less hawkish

• The disappointing housing data from last week put downward pressure on the USD. Housing Starts and Building Permits declined by 0.5% and 11.2%, respectively. This data overweighted the positive impacts from the November CB's Consumer Confidence, which rose to 7.2% from 6.9% in October.
• The terminal rate projected by Fed Fund futures is 4.9% (see table below). Although close to a pause, expectations are building for rates to remain elevated for longer.
• Risk to current market bias: If inflation continues to inch lower, the Fed may need to remain hawkish, potentially raising the terminal rate beyond 5%.

UK pound (GBP)
Market Bias: Bearish

• The UK economy shrank, and the GDP contracted by 0.3% to 1.9% in Q3. This data missed the market expectation of 2.4%. The economy has been hit by surging energy prices and high inflation. The UK has the worst growth among the G7 countries, according to the Office for National Statistics (ONS).
• Government support on energy bills for homes and businesses and high interest payments pushed the UK government to borrow £22bn in November, a record high for a month. The increasing budget deficit could further weaken GBP.
• Risk to current market bias: The UK economy is poised to continue underperforming, and no Bank of England speaker is scheduled until the first week of January. The pound may strengthen on general USD weakness.

Euro (EUR)
Market Bias: Bullish

• In addition to the 50bps rate hike this month, the European Central Bank (ECB) maintained a hawkish tone and stated that half-point hikes might soon become the “new norm” in the near term as there is no alternative to fight soaring inflation.
• Consumer sentiment surprisingly improved while entering the holiday season but was still far below the long-term average. Euro area Consumer Confidence Flash of December rose modestly. German Ifo Business Climate, which measures entrepreneurs’ sentiment about current and future business situations, improved.
• Risk to current market bias: The risk of a deeper recession persists and could potentially put a pause on the ECB rate hikes.

Canadian dollar (CAD)
Market Bias: Bearish

• The Year-over-year (YoY) inflation rate in Canada eased to 6.8% in November compared with 6.9% in October – not cooling as rapidly as many would like. General price pressures remain high, especially housing costs, which accelerated due to rising mortgage interest costs and rent.
• Bank of Canada (BOC) rate hikes, which have kept pace with the Fed in 2022, have supported the currency, but this may be soon coming to an end.  BOC stated that future hikes would be guided by economic data. Most economists think Canada will enter a technical recession at the beginning of 2023, and there are signs of a slowdown in other areas, including housing.
• Risk to current market bias: More aggressive rate hiking would result in CAD strengthening.

Japanese yen (JPY)
Market Bias: Bullish

• The BOJ’s unexpected announcement to welcome higher bond yields is another example of central banks globally continuing to be vigilant about the strong USD and spiraling inflation.
• The expectation is that higher yields will attract capital back to Japan, propagating the JPY higher and cooling inflation in the process.
• As the world’s largest creditor, Japanese investors invested overseas will likely increase their hedging activity of assets back to JPY, resulting in further JPY strengthening.
• Risk to current market bias: The path for the JPY heavily depends on whether the BOJ starts a tighter monetary policy regime next year. If interest rate differentials versus other countries remain wide, downward pressure on the JPY should remain.

Market Bias: Bearish

• The Peoples' Bank of China (PBOC) keeps benchmark lending rates unchanged, but most economists see an increasing possibility of a cut on the 5-year rate to stimulate housing markets. Home prices in China have fallen for the 15th straight month. 
• Capital outflows have been putting the exchange rate under downward pressure. Investors have sought to take advantage of the widening interest-rate differential between the US and China.
• Risk to current market bias: The PBOC responded to renminbi depreciation by injecting liquidity into the financial system, but they did not intervene in the FX market. If Chinese growth can rebound next year, net capital outflows would decrease or even reverse, providing support to the RMB.