G10 FX Weekly: USD Consolidation to Continue, Be Patient Shorting GBP

Summary

• The collapse in US yields brought the dollar with it. In previous collapses, the following month saw $-bloc outperformance and GBP underperformance.
• Similar instances proved neutral for the dollar. Our recent work suggested the December downside will likely come in the second half of the month.
• CHF is back to record highs. We think it will be very tough to fade CHF strength in the coming weeks.

Market Implications

• Patience remains the byword for December.
• USD is likely to drift lower this month but will probably continue to consolidate in the next week or two.
• We like long EUR/GBP but will wait for better buying levels.
• GBP/AUD downside is also attractive but, again, we wait for better levels.

The Path for G10 FX Following Strong USD and UST Moves

The dollar ended November down 3%, recovering some of its losses on the final day or two. So far, in the first few trading days of December, the dollar has edged higher.

Meanwhile, US yields have been stabilising at lower levels, after their steep drop last month. The US 10-year yield fell 60bps in November, the biggest one-month drop since 2008. Even the US two-year yield – which the Fed’s on-hold monetary policy anchors somewhat – dropped the most since the March banking tumult.

What Does It Mean for G10 FX?

After these big moves last month, the dollar and US yields could consolidate in the next week or two. After all, the moves were steep and fast. So a pause in this latest trend, with a slight retracement higher, would be a reasonable expectation. This aligns with likely small increases in yields in previous periods that have followed similarly sharp declines in UST yields (Chart 1).

Even upside and downside arguments are light. That said, Friday brings event risk with the US jobs report – it will be watched incredibly closely given the massive Fed repricing of recent weeks.

Also, as we wrote last week, further USD downside will probably occur in the second half of the month. After US jobs and the Fed, the drift lower might continue. Such a move could prove modest given how sharply the dollar sold off last month. The bulk of the often-seen December seasonality (USD weakness) has probably already occurred in November.

For the rest of G10, we find this recent move will benefit the $-bloc currencies (AUD, CAD, and NZD) the most, with AUD likely to lead, and hurt GBP most (Chart 2). That benefits our view that GBP/AUD is an attractive cross to turn short. It is near the top of its recent range and likely to benefit from extensive risk appetite.

Patience Is a Virtue in Shorting GBP

Broadly, we remain bearish GBP. But, as previously highlighted, we expect better selling levels in various pairs. Here is an update on our GBP thoughts:

• EUR/GBP – We warned last week of material downside in the pair. This was partly, although not totally, a month-end phenomenon, with EUR/GBP having its worst week in three months last week. The pair settled below 0.8600 for the first time since September. If we are right about USD weakness towards month-end, we think this will also weigh on EUR/GBP, as GBP/USD will probably outperform EUR/USD. We will reexamine EUR/GBP upside in the new year.
• GBP/AUD – The pair is still stuck in the 1.8950/1.9350 range we outlined two weeks ago. As then, we are monitoring price action and look to sell nearer the top of the range or on a break below the low.
• GBP/NOK – The pair is grinding higher, currently trading at ~13.70, back towards the top of the ~12.90/13.90 range of the past six months. We will monitor price action in the pair.

CHF Returns to Record Highs

On a trade-weighted basis, the Swiss franc is back at a record high. In the G10 space, CHF is the best-performing currency of 2023, up ~6% versus the dollar.

Since late September (the most recent trough for the franc), the CHF TWI is up 3%. Haven flows drove much of the strength following tensions in the Middle East.

Sadly, we expect geopolitical tensions there and elsewhere will persist. Therefore, investors will likely buy any CHF dips and keep the currency supported.

The Swiss National Bank (SNB) meets on 14 December to announce its quarterly monetary policy update. While we expect policy unchanged, what policymakers say about the currency will be interesting.

Throughout the tightening cycle, the SNB has maintained its policy of supporting the CHF, both verbally and through actual intervention, hoping to counter imported inflation.

With global inflation fears abating, and Swiss inflation already below target (headline CPI at 1.7%, core CPI at 1.5%), we will watch for any change in communication regarding the currency.

We expect next week is too soon for a language shift, but we think this will be the key thing to look out for in the statement.

Absent a shift away from supporting the currency in the market, it will be very tough to fade CHF strength in the coming weeks.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)