• DXY Sees Largest Drop Since August: The dollar index (DXY) fell sharply, driven by hawkish ECB comments and end-month rebalancing flows as fund managers adjusted portfolios following strong U.S. equity performance (+5.1% S&P 500) and weaker European and Japanese markets.
• Mexican Peso Volatility Spikes: The peso rallied 1% after Trump’s claims of a border agreement with Mexico’s President Sheinbaum, though differing narratives and elevated volatility (USD/MXN realized at 15%) signal ongoing risks, deterring carry trade inflows.
• Dollar’s Mild Headwinds: Potential negatives include a Middle East ceasefire, softer U.S. data building Fed rate cut expectations (17bp priced for December), but the dollar remains supported by high U.S. rates and European political instability.
• EUR/USD Gets a Boost from ECB’s Schnabel: Comments from Isabel Schnabel opposing aggressive rate cuts and indicating a gradual easing approach helped narrow rate spreads, but political risks in France and fiscal concerns in the eurozone limit further euro gains.
• GBP Divergence with Yield Spreads: GBP/USD reflects UK economic pessimism and fiscal sustainability concerns rather than bond yield movements, a shift that could reverse if labor market data aligns with business caution.

DXY Dips: Largest One-Day Correction Since August

The DXY dollar index experienced its most significant one-day drop since early August. While U.S. economic data wasn’t particularly weak, two key factors likely contributed to this decline. First, hawkish remarks from the ECB’s Isabel Schnabel (details below) stirred markets. Second, end-of-month rebalancing by fund managers likely played a role. For instance, a global equity portfolio in USD terms reveals the S&P 500 is up 5.1% month-to-date, while the Eurostoxx 50 and Japan’s Nikkei 225 are both down 1.9%. In bonds, U.S. portfolios gained 0.65%, compared to a 1.0-1.5% decline in core Europe and flat returns in Japan. This discrepancy likely prompted upward adjustments in non-USD portfolios, with some of this activity hitting liquid markets ahead of Thanksgiving-thinned conditions.

Overnight, the Mexican peso rallied 1%, following President-elect Trump’s claim of a “wonderful conversation” with Mexico’s President Claudia Sheinbaum. Trump announced an agreement to close the U.S.-Mexico border, though Sheinbaum’s statements suggested otherwise. This highlights ongoing volatility in Mexican assets, as seen in USD/MXN’s three-month realized volatility surging to 15% from 7% in March. High volatility discourages carry trade inflows, keeping peso gains limited.

Looking ahead, mild headwinds for the dollar could emerge. A Middle East ceasefire may bring calm, while soft U.S. data next week could revive expectations for a 25bp Fed rate cut in December, with 17bp of that cut currently priced in. However, the dollar remains supported by elevated U.S. interest rates (4.61% on one-week deposits), European political uncertainty, and potential tariff-related social media shocks.

Technically, the DXY is expected to find support near 106.00. A break below 105.70, however, would prompt a reassessment of the multi-week outlook.

EUR: Schnabel Pushes Back on Aggressive December Cuts

EUR/USD found some relief following an interview with ECB member Isabel Schnabel, who emphasized the need for gradual easing. Schnabel’s comments, suggesting neutral rates between 2-3% and opposing a 50bp December cut, caused market expectations for a December rate cut to narrow from 38bp last week to 28bp now. This narrowed the U.S.-Eurozone rate spread by 8bp, offering modest EUR/USD support.

However, French political risks loom, with Marine Le Pen’s faction potentially destabilizing Michel Barnier’s government over a budget vote. This has widened the French-German 10-year bond spread to levels unseen since 2012, adding eurozone fiscal concerns. Given this backdrop, EUR/CHF may slide back toward the 0.9200/0.9210 range, where SNB intervention could stabilize it.

Today’s eurozone calendar includes November confidence data (likely weak) and German inflation figures (expected to rise slightly). For EUR/USD, 1.0565/1.0580 might cap gains in the short term, with a drift back to 1.0500 likely in quieter trading conditions.

For further insights, check out our trade team’s piece on Europe’s response to Trump’s tariffs, especially Christine Lagarde’s interview in Financial Times on this subject.

GBP: Disconnect Between Cable and Bond Yields

Lloyds Bank analysts note a divergence between GBP/USD (Cable) and gilt-UST yield spreads. Despite steady gilt yields, GBP reflects pessimism about the UK’s economic outlook, partly driven by concerns over fiscal sustainability and an expansionary budget.

Historically, Cable has closely tracked 5-year bond yield spreads, but this link has weakened in November. FX markets are more focused on UK fiscal risks, with employer NIC increases adding to economic worries. This disconnect could resolve if labor market data begins to reflect business caution, realigning GBP with yield spreads.