EUR (1.090) ▲

• Both the European Central Bank (ECB) and the Fed decided to maintain their status quo in December. However, the Fed's shift towards a dovish stance triggered a significant downturn in both the USD index (DXY) and the 10-year US Treasury yield, thereby bolstering the EUR. However, the EUR's gains were capped by the ECB's subtle lean towards dovishness, coupled with diminishing inflationary pressures and lacklustre economic indicators across the eurozone.

• Elevated borrowing costs and the depletion of consumer savings are expected to impact the US economy soon, potentially prompting the Fed to implement more rate cuts than indicated for 2024. Consequently, the DXY is anticipated to trend lower as investors continue to unwind their long USD positions, driving the EUR to conclude 2023 at around 1.10/USD. Nevertheless, EUR remain under pressure due to the looming possibility of the bloc's economy slipping into a recession in 2024.

GBP (1.268) ▲

• The divergence between the Bank of England (BoE) and the Fed's tone has helped to boost the GBP above the 1.26 level against the USD. Notably, the BoE maintains its hawkish stance, underscored by the endorsement of three hawks voting for an additional hike in December. In contrast, the Fed adopts a softer tone. Despite still robust US economic figures (i.e. retail sales), the market continued to price in more rate cuts by the Fed in 2024, benefiting the pound.

• The GBP is expected to close 2023 around the 1.27 level, with potential for continued strengthening in 1Q24 as the BoE may continue to push back against the market dovish expectations. However, any emerging signs of economic fragility in the UK may compel the BoE to reconsider its stance, thereby exerting downward pressure on the GBP and limiting its gains against the weakening USD.

Source: Kenanga Research - 18 Dec 2023