After the ’s hawkish tone helped the euro last week, we think the same can happen with the and the dollar, as rates are likely to be raised by 25bp on Wednesday and the tone may stay hawkish. Gulf developments remain concerning, and some AI-related headlines are further weighing on equities – an environment where the dollar should remain supported.
USD: External and Domestic Drivers Positive for USD
The dollar has opened the week on a strong note, catching up with a combination of supportive domestic and external developments. Domestically, last week’s hotter-than-expected print has all but sealed a Federal Reserve rate hike on Wednesday (preview here). Consensus is nearly unanimous, and markets are pricing 22bp. That may suggest limited USD upside on the day, but the currency still has room to catch up with higher front-end rates, while the Fed may retain a hawkish tone given the bond market’s demand for policy credibility and recent rise in energy prices.
Externally, oil prices are rising again today after Saudi Arabia shut the East-West pipeline following drone attacks from Iraq. The pipeline is a critical alternative to the Strait of Hormuz for roughly 7m bbl/day of exports. At the same time, Oman-led talks with Iran and other Gulf states on a temporary shipping route through the Strait have been postponed. Against that backdrop, risk sentiment should remain fragile, with calls from prominent tech figures to slow AI development adding pressure to already dwindling equities.
We continue to favour a moderately stronger dollar from here. A message of monetary policy rigour by the Fed on Wednesday can help slowly rebuild the positive USD-Treasury yield correlation, allowing the greenback to function more efficiently as a safe haven. A return to the 99.50-100.0 in remains a tangible possibility in our view, and fully in line with current drivers.
One risk to that view is US President Donald Trump’s pledge to send $5k to every American should Republicans win Congress in the midterms. Markets remain sceptical about the proposal, both because of the legislative hurdles and because Democrats maintain a comfortable House lead in polls and prediction markets. Even so, the pledge may signal a willingness to deploy fiscal measures ahead of the vote despite persistent concerns about debt sustainability. Any indication that similar measures are being taken seriously could trigger a rise in the USD risk premium.
EUR: Eyes on ZEW and Lagarde Today
finally broke below 1.1600 yesterday, and we continue to favour further downside in line with our constructive USD view. That said, last week’s hawkish European Central Bank messaging may slow the pace of the decline. Our near-term target remains 1.1500.
The Governing Council’s view that additional tightening may still be required is likely rooted, at least in part, in the eurozone’s unexpectedly resilient growth backdrop. With the placing greater emphasis on high-frequency indicators, tomorrow’s German ZEW survey will be closely watched. Consensus looks for improvements in both the expectations and current conditions components.
This week also gives ECB officials scope to refine last week’s policy message. President Christine Lagarde is due to speak in Vienna this afternoon, while Isabel Schnabel and Piero Cipollone are scheduled earlier in the day. Our macro team remains sceptical that the ECB will deliver further hikes, but developments in the Gulf may keep policymakers leaning hawkish for the time being.
JPY: Downside Risks This Week
The Bank of Japan looks likely to hike rates by 25bp on Friday (see our preview here). Markets are fully discounting the move, and we see little risk of a surprise hold. If anything, there is a small outside chance of a larger 50bp increase, although we suspect that would be met with some discontent from the growth-oriented government.
We see downside risks for the yen this week, though. A hawkish Fed hike on Wednesday could encourage a rebuilding of speculative long positions, while the may fall short of validating market expectations, with a December hike already fully priced in. Some JPY bulls may also be looking for an announcement on a domestic shift in GPIF portfolio allocation as early as this week and could be disappointed if none materialises.
Short-term valuation metrics need to be interpreted cautiously for USD/JPY, but they still point to around 2.5% undervaluation in the pair. Against that backdrop, a move back to 156-157 this week appears to be a reasonable near-term target.
CEE: Dovish CNB to Keep on the Rise
The calendar starts on Monday with current account data from Poland and the Czech Republic. Poland’s final CPI reading (expected at 3.4%) follows on Tuesday, while Wednesday brings Czech producer prices, alongside Polish core inflation expected at 3.2% and Hungarian wage data at 8.1%.
The Czech National Bank’s upcoming decision will be the main regional event on Thursday. We expect no change in the 3.75% rate, with markets focused on policy guidance and any signals about the timing and pace of future rate moves. The week closes with Polish industrial production on Friday.
Friday’s US inflation data offered some relief after higher global energy prices and a hawkish ECB outcome triggered a sell-off in CEE rates. However, the market remains more hawkish than our economists’ forecasts, and this is unlikely to change without a meaningful decline in global energy prices. The CNB should strike a dovish tone, helping to reduce rate hike expectations. We see further upside in EUR/CZK and expect the pair to approach Thursday’s meeting around 24.300, with scope to rise further if the CNB confirms its dovish stance and the US dollar strengthens.
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