Dollar seeks footing in re-basing move

The U.S. dollar has extended its modest recovery as gold and silver have sold off sharply, and conditions now appear stable enough for incoming data to drive FX markets this week. The U.S. economic calendar is set to culminate in solid payrolls and unemployment figures, potentially leaving room for further upside in the dollar.

Elsewhere, the European Central Bank may avoid focusing heavily on the euro in its messaging, while the Reserve Bank of Australia could deliver a rate hike as soon as tonight.

USD: Some Health Restored

The dollar is showing renewed strength. The de-basement trade that appeared to drive last week’s sharp decline in the USD has begun to unwind following Kevin Warsh’s nomination by President Donald Trump as the next Federal Reserve chair. The steep correction in previously overbought precious metals has likely provided additional support for the dollar, although we have consistently argued that the earlier USD selloff had become overly disconnected from underlying macro fundamentals.

With the dollar now partially recovered, we expect price action to realign more closely with incoming data and short-term rate dynamics this week. The U.S. economic calendar is busy, featuring ISM surveys (with manufacturing due today), JOLTS and ADP reports ahead of Friday’s payrolls release. Our expectation is for around 80,000 jobs added and an unchanged unemployment rate of 4.4%, which could help underpin further stabilization or recovery in the dollar.

In the meantime, we are watching closely for signs of dip-buying interest in EUR/USD. We see the key support zone around 1.1880–1.1900, and the recent break below this area suggests some renewed confidence in the dollar. A renewed rally in the euro without clear data or event-driven justification would imply that damage to the dollar may be more persistent. For now, however, we maintain a short-term bullish outlook for the USD.

EUR: Concerns over euro strength may be overstated

This week’s key question is how concerned the European Central Bank truly is about the euro’s recent appreciation. With EUR/USD no longer hovering near the much-feared 1.20 level, the likelihood of an explicit reaction from ECB officials has diminished—any comments were always more likely to emerge after the meeting or in the minutes rather than in the main policy statement.

At Thursday’s meeting, there may be little to prompt a change in President Christine Lagarde’s long-standing reluctance to comment on exchange rate levels. At the same time, markets do not appear to be pricing in significant risk of verbal pushback against euro strength, suggesting that the threshold for a negative euro response is relatively low.

Eurozone core inflation data due on Wednesday are expected to ease slightly to 2.2%. Our economists see a marginally higher print of 2.3%, but either outcome is unlikely to have much impact on the currency. For now, EUR/USD should continue to be driven largely by dollar sentiment, and if confidence in the USD continues to recover as expected, we see the pair moving toward our short-term fair value estimate of 1.1770 in the near term.

AUD: RBA rate hike hangs in the balance

The Australian dollar has been among the hardest hit by the abrupt unwinding of long positions in gold and silver. More broadly, AUD/USD appeared to be pricing in an excessive amount of optimism in January, particularly given unchanged interest rate differentials. Unlike EUR/USD—where rate expectations have shifted little on the euro side—AUD/USD has seen notable moves at the front end of the curve on both sides.

Markets are now pricing in around 19 basis points of tightening from the Reserve Bank of Australia at tonight’s meeting, and we align with consensus in expecting a 25 bp rate hike to 3.85%. That said, the decision looks finely balanced. While the upside surprise in December CPI, coupled with a strong housing market, supports a hike, the RBA is unlikely to signal the start of a new tightening cycle. With markets already pricing at least one additional hike by year-end, any indication that this move is “one and done” would limit the support a hike could provide to the Australian dollar.

In our view, the impact of RBA tightening on AUD/USD is more likely to become apparent beyond the near term, once the overwhelming volatility in the U.S. dollar subsides. Consistent with our USD outlook, and given that market pricing is already skewed toward a hawkish outcome, we expect AUD/USD to trade lower in the coming weeks before eventually settling into a more sustainable recovery path beyond the 0.70 level.

Sources: Francesco Pesole