USD Strength, Euro Weakness, and GBP Uncertainty.

• USD Strength: U.S. retail sales boosted the dollar, with USD/JPY breaking above 150.0. Further upward movement may be capped by potential Japanese intervention, while Fed rate cuts remain uncertain.
• Election Risk: The U.S. election could drive defensive dollar flows, pressuring the Australian and New Zealand dollars, with additional focus on China’s growth and trade concerns.
• Euro Weakness: A dovish ECB tone and widening swap rate gap with the dollar have left EUR/USD under pressure, with potential for further downside to 1.070 before month-end.
• GBP Outlook: Strong UK retail data has supported sterling, but a dip in services inflation raises expectations of BoE rate cuts, with downside risks for GBP/USD toward 1.28.
• Commodity FX: Canadian dollar expected to outperform, with markets anticipating a possible 25-basis point rate cut by the Bank of Canada next week.

USD:
U.S. retail sales surged yesterday, perfectly timed 15 minutes after the European Central Bank (ECB) rate cut, propelling the dollar higher. The USD/JPY pair finally broke above 150.0, but a straight-line rise is unlikely, as Japanese authorities may intervene verbally. The market should keep a close eye on currency comments, as recent Bank of Japan interventions have been successful.

Unless market sentiment shifts toward confidence in Fed rate cuts, the dollar is not expected to see much downside in the short term. In fact, if core PCE and October job numbers exceed expectations, one of the anticipated cuts (either in November or December) might be priced out, as only 42 basis points are currently factored in.

The bigger threat to the dollar is the upcoming U.S. election. We anticipate some de-risking leading to defensive flows into the dollar as November 5 approaches, potentially pushing the Australian and New Zealand dollars lower. Their vulnerability to tariffs on China may overshadow any positive impact from Beijing’s stimulus. China’s 3Q growth came in at 4.6% year-on-year, slightly above the 4.5% forecast. Meanwhile, the Canadian dollar is expected to outperform among commodity currencies, particularly with a potential 25-basis point rate cut by the Bank of Canada on the horizon.

In the U.S., the day’s data is light, focusing on September housing figures. Markets will watch for any hawkish signals from Fed speakers, following yesterday’s strong retail sales. The DXY index could see short-term corrections but may climb above 104.0-104.5 in the coming weeks.

EUR:
ECB President Christine Lagarde adopted a more dovish tone than usual, expressing greater confidence in the eurozone’s disinflation trajectory. While she reiterated that economic activity only influences policy as it affects inflation, the focus seems to be shifting from inflation control to growth concerns. According to Carsten Brzeski, the ECB’s own projections aligned with September’s inflation drop, but weak PMIs may have swayed the ECB toward a more dovish stance.

If growth takes center stage, further ECB rate cuts seem likely, with markets already pricing in 100 basis points of easing over the next four meetings. This is probably the most the ECB can deliver, though there’s some risk of hawkish repricing in early 2024. In the near term, however, the euro remains under pressure, with limited upside as the swap rate gap with the dollar widens to -140 basis points, its widest since May. This dynamic could keep EUR/USD below 1.080, with 1.070 potentially within reach by month-end, especially as the U.S. election looms.

GBP:
UK retail sales in September exceeded expectations, following a strong August, signaling that the economy remains relatively robust. Consumers are benefiting from solid real wage growth, although we don’t anticipate the high growth rates from earlier in the year to persist. However, growth is secondary to inflation for the Bank of England (BoE). The recent drop in services inflation raises the likelihood of back-to-back rate cuts.

Sterling has shown more resilience than expected despite the services inflation surprise. Cable has held steady around 1.30 but hasn’t made a decisive move lower yet. We still see downside risks for GBP, particularly with the two-year swap rate gap between sterling and the dollar tightening from 55 basis points at the start of October to just 19 basis points. The last time the spread was this narrow, GBP/USD traded at 1.28, and absent major downside surprises in U.S. data, we expect a move toward that level.