• USD Strength Holds Steady: The dollar remains firm as markets digest US tariff developments, with limited reaction to geopolitical news and minimal impact on US rates markets from inflationary risks.
• Key Inflation Data in Focus: October’s core PCE deflator (0.3% MoM) may be slightly high for the Fed, but it’s already priced in. Fed rate cuts of 15bps for December remain expected, supporting a bullish dollar outlook.
• Rebalancing Risks for USD: Month-end rebalancing flows, driven by strong US equity performance (S&P 500 +5.3% month-to-date) versus European and Japanese counterparts, could create short-term selling pressure on the dollar.
• EUR Faces Headwinds: EUR/USD struggles due to weaker sentiment in the European auto sector and limited eurozone data. Oversold conditions may offer support near the 1.0400 level ahead of potential rebalancing flows.
• GBP Gains from Stability: Sterling benefits from high G10 deposit rates (4.75%) and a BoE outlook aligned closer to the Fed than the ECB. GBP is poised to outperform the euro, with year-end EUR/GBP forecasts around 0.83.

USD: Sticky Inflation and the Fed’s Dilemma

The US dollar stayed relatively firm on Tuesday as markets processed new US tariff developments, with little reaction to news of a peace agreement between Israel and Hezbollah. Beyond some predictable pressure on the Mexican peso and US automakers with facilities in Mexico, there was minimal impact on US interest rate markets. For now, the inflationary effects of potential tariffs remain absent from US asset movements.

In focus today is the release of October’s core PCE deflator. A month-on-month increase of 0.3% may still be uncomfortably high for the Federal Reserve, though this figure is already factored into current market expectations. The market continues to price in 15 basis points of Fed rate cuts for December while maintaining wide US rate differentials compared to other major economies.

We maintain a bullish stance on the dollar. Today’s US data, including confirmation of third-quarter GDP growth at an annualized 2.8%, will likely reinforce dollar strength heading into the holiday-shortened week. However, month-end rebalancing flows could present downside risks. The stark divergence in performance among dollar-based equities (S&P 500 +5.3% month-to-date) and counterparts like the Eurostoxx 50 (-1.36%) or Nikkei 225 (-1.6%) suggests rebalancing may lead to dollar sales. Should the DXY index dip to the 106.25-106.50 range, strong buying interest is expected.

EUR: Struggling to Find Momentum

EUR/USD failed to gain traction yesterday despite underwhelming US macroeconomic data. The European auto sector, still reeling from potential pre-election US tariff threats, likely weighed on the euro. German carmaker stocks dropped 3-6% in response.

With a quiet eurozone economic calendar today, EUR/USD movements will largely hinge on US inflation data. After a steep 6-7% decline over the past two months, EUR/USD appears oversold. Any drop towards the 1.0400-1.0425 level could stabilize ahead of potential month-end dollar sales tied to rebalancing.

GBP: Riding High as a Market Spectator

Sterling benefits from its status as an “innocent bystander,” with one-week deposit rates at 4.75%—the highest among G10 currencies. This rate advantage may draw inflows as markets weigh the implications of Trump’s policy trajectory. Additionally, the Bank of England’s interest rate outlook aligns more closely with the Fed than the ECB, positioning the pound to outperform the euro. We anticipate EUR/GBP to close the year around 0.83, not far from current levels.

That said, the risk leans more towards 0.82 than 0.84, as the UK is less trade-sensitive and the BoE continues to focus on service-sector inflation. Huw Pill, the BoE’s Chief Economist, reiterated yesterday that late-cycle inflation remains a priority for policymakers.