Next Week: Six G-10 Central Banks Meet, But Only Two Move--BOE Cuts and BOJ Hikes

[Ben Graham]

Encouraged by the Federal Reserve's rate cut and its T-bill purchases, the dollar was sold. The Dollar Index fell for the fourth week in the past five. Leaving aside the Bank of England, which will most likely cut rates in the week ahead, the easing cycle of most of the other G10 central banks appears complete. The median dot in the Fed's new Summary of Economic Projections remained at one cut next year, while the market, perhaps with eye toward the personnel changes, anticipates at least two cuts next year. We have anticipated this divergence in the trajectory of monetary policy, which has driven our dollar bearish outlook. However, as we discuss below, the market has absorbed the news, and the momentum indicators warn that the dollar's decline is over-extended in the near-term. A period of consolidation seems likely.

The week ahead features six G10 central bank meetings (ECB, BOE, Norway's Norges Bank, Sweden's Riksbank, the RBNZ and the BOJ). Most will not change rates. The exception is the Bank of England, which will cut, and the Bank of Japan, which will hike. Two Latam central banks meet (Chile and Mexico), and both will likely cut and signal at least a pause. The Czech central bank meets, but its easing cycle ended in May and looks to on hold for the next couple of quarters at least. The US economic calendar plays a bit of catch-up with the November jobs and CPI, and October retail sales. The preliminary December PMI will also be released for many of the economies we track. 

US

Drivers: The Federal Reserve's rate cut coupled with new effort to provide ample reserves via T-bill purchases sent the greenback lower. The US two-year premium over Germany narrowed to the least since the 2024 low in September near 135 bp. The US 10-year premium over Japan is hovering near 220 bp, after falling to about 215 bp, lowest since April 2022. As the year winds down, the Federal Reserve and the Bank of England are the two G10 central banks where the monetary easing cycle has the greatest chance of being extended next year. The narrowing of the US trade deficit in Q3 24 (~$207.3 bln vs.~$231.3 bln in Q4 24) appears to be more a function of tariffs than a fairly valued exchange rate. The dollar's remains broadly overvalued. The real broad trade-weighted dollar is still at the upper end of where it has been in the last 40 years. 

Data: While government data resumes, the impact may be marginal, especially given last week's rate cut. Before the Fed meets again in late January, it will have another cycle of high frequency data in hand. That said, the November jobs report and CPI will help shape market psychology going into the new year. The median forecast in Bloomberg's survey is for a 40k increase in non-farm payrolls and for the unemployment rate to have remained where it was in September, 4.4%, the highest since October 2021. CPI is expected to have edged up, with the headline rate pushing above 3.0% for the first time since May 2024. The year-over-year pace has not fallen since April. The core rate is also seen rising to 3.1% from 3.0%, where it was in July and August before slipping to 3.0% in September. October retail sales will be reported, but we know two things that point to a soft number: We already know that auto sales fell sharply as the subsidy for EV ended and that consumer credit slow by almost $2 bln. 

Prices: The Dollar Index fell to about 98.15 last week and held a little above the (61.8%) retracement of the rally from the year's low on September 17, which is found near 97.80. The market has digested the news, and a consolidative/corrective phase could be at hand. There may be potential in the band of resistance now seen in the 98.60-85 area. The trendline off November 21 and 25 highs and last week's high comes in around 98.70 next week and near 98.00 at the end of the year. 

EMU

Drivers: The 30-day correlation between changes in the euro and US 2-year interest rate is near -0.45. The rolling 30-day day correlation of changes in the exchange rate and the US-German two-year differential is near -0.40. The correlation between changes in the euro and the German two-yield was inverse from early May through late November and is now slightly positive. The correlation with the 10-year German yield was positively correlated in the first 3 1/2 months of the year but spent the following eight months inversely correlated. It popped back into a positive correlation briefly at the end of November and early December, but it is slightly inverted again. 

Data: The aggregate October industrial production estimate will be made but we already know national figures, so the market's reaction tends to be minimal. The preliminary PMI will be reported on December 16 and there could be more of a market reaction. However, the highlight of the week is the ECB meeting. There is virtually no chance of a change in policy, but President Lagarde's press conference is often impactful, and the staff will update its forecast, which serve as a type of forward guidance. 

Prices: With the help of the Federal Reserve, the euro met the (61.8%) retracement of its decline from the year's high on September 17. Yet, it did not close above that retracement objective, slightly below $1.1750. The momentum indicators are stretched, warning of the risk of a corrective/consolidative phase. Initial support may be in the $1.1690-95 area, and then $1.1640. 

PRC

Drivers: The PBOC has guided the dollar lower against the yuan through the setting of the daily reference rate. It seems that China's trade flows might not be very sensitive to the yuan's movement, though the IMF claims the opposite. The gradual appreciation of the yuan, and we are still talking about rather small moves, may have other benefits for Beijing, such as easing some trade frictions on the margin, boosting the purchasing power of Chinese consumers and Chinese businesses engaged in direct investment. Even while the PBOC has guided the dollar lower, there are press reports of state-owned banks purchasing dollars. Even many of Chinese critics and those that argue that state-owned banks are used for stealth intervention seem reluctant to push that line now. At the end of last week, Beijing announced a new initiative to check steel exports after record shipments this year. The broad licensing regime will begin January 1 and covers 300 specific products according to reports. Also, the Central Economic Work Conference guidance for next year seems to hold open the prospect of easing monetary policy. 

Data: On December 15, China reports November macro data, including retail sales, industrial production, capital investment, and an update on the property sector, including new and used house prices. Retail sales and industrial output appear to be stable, rising slightly less than 3% year-over-year and around 5%, respectively. Capital investment contraction is deepening, and what this will lead to is a decline in the share of investment as a percentage of GDP and a commensurate rise of consumption. Meanwhile, the property market drag remains substantial. 

Prices: The dollar traded below CNH7.05 last week, though held about CNY7.0545 last week. The greenback has not been lower since October 2024. It has fallen by a little more than 1% over the past four weeks. The CNH7.07 area may offer initial resistance during a broader dollar consolidation phase. Many have suspected that officials allowing the dollar toward CNY7.0, where it bottomed last year in September. The low in 2023 was near CNY6.70. We think it can return toward that area in 2026. 

Japan

Drivers: The conventional narrative claims that higher rates in Japan will spur Japanese investors to repatriate funds. While there is an intuitive element here, it is dangerous. Japan runs a current account surplus of a little more than 4.5% of GDP and that requires it to export its savings. Moreover, the narrative often fails to take into account two other elements. First, changes in the exchange rate and hedging, and sometimes the currency transaction could be the key to the total return. Second, the conventional narrative often ignores what foreign investors are doing in Japan's asset markets and currency. Over the past 30- and 100-days, the dollar-yen exchange rate remains more correlated with the 10-year US Treasury yield than the 10-year JGB yield. For the shorter timeframe, the correlation with changes in US yields is about 0.30 and less than half for the JGB. For the longer timeframe, the correlation is about 0.56 for US Treasury and less than 0.02 for the JGB. 

Data: There are several high-frequency economic reports in the coming days, which under different circumstances could be impactful, but with the Bank of Japan meeting concluding on December 19 and a rate hike deemed highly likely, the data may pose little more than headline risk. Early Monday, the BOJ's Tankan Survey will be released. It is not expected to be much different than the Q3 reading. The capex plans will be compared with the Q3 intention of a 12.5% increase. Small businesses are struggling more than large businesses. The tertiary industry (services) activity for October will also be reported early Monday. The economy contracted by 2.0% at an annualized rate in Q3, and Q4 is off to a stronger start. Industrial output rose 1.4% in October. Tertiary activity rose by 0.3% in September, the strongest pace since May. November trade figures are also on tap. There is strong seasonal pattern for deterioration. Despite the undervalued yen on most metrics, Japan runs a trade deficit. In the first 10 months of the year, the monthly shortfall averaged almost JPY307 bln a month (~JPY563 bln in the Jan-Oct 2024 period and about JPY874 bln a month in 2023). The national CPI captures the attention of journalists, but market participants get their signal from the Tokyo CPI, which was out a few weeks ago and showed broad stability at elevated levels: 2.7% headline, 2.8% core, and 2.8% excluding fresh food and energy. The role of rice remains significant. 

Prices: The dollar stalled near JPY157 last week and pulled back to slightly below JPY155 in the post-Fed sell-off. It did not seem to break the spirit of the yen bears. And with the US 10-year yield apparently not done pushing higher, the risk is the greenback advances. A move above the JPY156.50 area may be an early warning of not only a retest of the JPY157 area, where the five- and 20-day moving averages converge, but maybe even a return the late November high, slightly below JPY158. The market has come around to a rate hike by the BOJ, and it is so well discounted that it would be more disruptive if it stood pat. The swaps market has one hike discounted for next year, but not until the middle of Q3. 

UK

Drivers: Sterling remains sensitive to the overall direction of the greenback. The rolling 30-day correlation of sterling and the Dollar Index is inverse around -0.80. It has not been less than -0.75 in four months, and it has briefly been more extreme than -0.90 over the last few years. Given that the euro is the largest component in the Dollar Index, we look at the correlation between changes in sterling and changes in the euro. The rolling 30-day correlation is a little less than 0.80. It has been in a range this year between about 0.65 and 0.92. 

Data:   It is an important week for the UK. The labor market update is due Tuesday, alongside the preliminary December PMI. Wednesday sees the November CPI. Thursday is the Bank of England meeting and there is little doubt in the market's mind. The BOE will cut rates for the first time since August. The swaps market is discounting another cut fully in H1 26, and about a 40% chance of another one in H2 26. The week concludes with November retail sales, which will likely bounce back after the 1.1% drop in October. 

Prices: Sterling reached almost $1.3440 last week, its best level since October 20, and slightly shy of the (61.8%) retracement of the losses since September 17 high. The momentum indicators are stretched, and some consolidation seems likely. Initial support is seen in the $1.3340-45 area, and a break could test $1.3300. Losses through the $1.3270-80 area would signal a deeper correction that may extend to the $1.3200 area. Also, sterling has lost its bid against the euro that it had enjoyed from mid-November through early December. 

Canada

Drivers:  The Canadian dollar has become less sensitive to the dollar's overall direction. The rolling 30-day correlation between the greenback's changes against the Canadian dollar and the Dollar Index peaked in August near 0.80. It is now around 0.35. The low for the year, in early February, was below 0.20. There is still a risk-sensitivity element in the exchange rate, which is inversely correlated with changes in the S&P 500. The rolling 30-day correlation is around -0.35. It has not been positively correlated since a brief period around mid-August. 

Data:   The Bank of Canada left rates on hold last week, as widely expected. It likely limits the reaction to this week's data, which includes the November CPI and October portfolio flows and retail sales. The market has begun pricing in increasing odds of a rate hike, especially later in 2026. Pricing in the swaps market is consistent with about a 20% chance of a hike by the end of H1 26, and around a 90% chance by early Q4 26. Bank of Canada Governor Macklem speaks to the Montreal's Chamber of Commerce on December 16, and he may caution against prematurely tightening financial conditions. 

Prices:  After falling in H1, the greenback rebounded against the Canadian dollar, retraced half of its losses and has come off sharply again. It begins the new week with a four-day slide in tow. The US dollar met the measuring objective of the double top objective near CAD1.3800 and marginally overshot the (61.8%) retracement of the rally since the mid-year low. The next target is the shelf forged in August and September around CAD1.3725. The three-week US dollar slide is the longest since April and momentum indicators are getting stretched, which is consistent with what we have observed in the other currency pairs. In a consolidative/corrective phase, the US dollar can recover into the CAD1.3800-CAD1.3825 area. That said, we expect a break of the 2025 low around CAD1.3540 in early 2026, setting up a test on the CAD1.3400 area. 

Australia

Drivers:  The Australian dollar's three-week 4% rally stalled with the disappointing November employment report. The market, fresh off the hawkish hold by the central bank and Fed rate cut, took a breather. The futures market had a hike fully discounted by the middle of next year but after the jobs data, the first hike now fully discounted by the middle of Q3 26. The rolling 30-day inverse correlation of changes in the Australian dollar and the Dollar Index is around -0.35. It had briefly been positive last month for the first time since early 2020. The correlation between changes in the Australian dollar and the US dollar against the Canadian dollar is inverse near -0.70, which is a three-month extreme. 

Data: The preliminary December PMI is the highlight of the week. Recall that the composite PMI stood at 52.6 in November. It has averaged 53.0 over the past six months, the best since before the pandemic. The average through November is 52.1 compared with 51.1 average in the same period last year and 49.4 in the first 11 months of 2023. The economy grew by 0.4% in Q3 and looks a little better in Q4. The RBA forecasts GDP this year to grow 1.8% this year and 1.9% next year. 

Prices:  The Australian dollar peaked last week near $0.6685, ahead of the year's high a little above $0.6700 recorded on September 17. Momentum indicators are stretched, and corrective pressures appear to be emerging. A break of the $0.6625 would be the first tell of a corrective that could extend toward $0.6550, with intermittent support around $0.6585. 

Mexico

Drivers:  Many observers suggested that the recovery of the yen seen in recent days amid the speculation of the BOJ hike and Fed cut would undermine the peso by ending a popular carry trade (long peso short yen). Yet the peso has risen to new highs for the year. The yen, after all, is not the only attractive funding currency. So are the Swiss franc and dollar, for example. From late May through early October, the rolling 30-day correlation of changes in the dollar against the yen and the dollar against the peso were positively correlated. In late September it reached almost 0.75, the highest since May 2021. The correlation has shifted back to inverse, where it spent most of the first 4 1/2 months of the year. Mexico's Congress gave final approval last week to a new tariff regime that targets not only China but the countries that use Chinese inputs to export. The new measures may boost Mexico's domestic prices, but it seems aimed at appeasing the US, for which in return, it may get some tariff reprieve and some good will going into next year's USMCA review. 

Data:  Several hours after October retail sales are reported, the central bank will announce the outcome of its meeting. The market is pricing in a strong chance of a rate cut and the 15 economists in Bloomberg's survey expect a quarter-point cut. The swaps market is pricing is consistent with this being the last cut in the cycle. 

Prices: The dollar was sold to a new low for the year ahead of the weekend. It briefly traded slightly below MXN17.99. The market shrugged off the sharp US equity losses, perhaps encouraged by the much stronger than expected October industrial production figures (0.7% vs. median forecast for a 0.1% gain). However, the selling pressure abated, and the greenback finished the week slightly above MXN18.01. Previous resistance in the MXN18.20-MXN18.25 area may now offer resistance. A sustained break of MXN18.00 could target the MXN17.60 area next. 

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