Forex market week ahead: dense data to start the new year, focusing on non-farm and euro area inflation

The dollar has had a major rollercoaster ride in 2023, as hopes of a Fed pivot have repeatedly been dented by unexpectedly strong economic data, which tend to come from a strong performance in the US labor market. But traders seem more certain this time around that the key point is coming, as Fed Chair Jerome Powell himself has subtly hinted at it.

So despite a strong rally in the summer and autumn, the dollar still looks set to end the year down almost 3 per cent against a basket of currencies. The rally was driven by a surge in US Treasury yields, which have since been hurt by rising expectations of a big rate cut in the year ahead. #2024Investment Strategy #

(Source: FXStreet)

The cumulative probability of a rate cut in 2024 is fast approaching 160 basis points. Given that the US economy is not in recession, and Federal Reserve officials are only forecasting three rate cuts of around 25 basis points, this seems excessive. The December meeting notes that produce these forecasts will be released on Wednesday (January 3), and FOMC members may try to use the publication to reinforce their view that policy will only be moderately accommodative in the coming years.

A jobs report that is not too cold or too hot

Another clue to the path of interest rates will be policymakers' outlook for the job market, as they have recently signaled that their focus on the Fed's other mandate - jobs - will increase as inflation falls.

That may explain Mr. Powell's lack of caution in his rush to guide policy towards easing, as he fears that keeping interest rates at restrictive levels for too long could push up unemployment. As far as the labour market is concerned, however, things have been good so far. Job growth has slowed but companies have not laid off many workers, allowing wages to rise modestly.

Analysts don't expect much to change in December. Nonfarm payrolls are expected to increase by 158,000, down from 199,000 in November, while the unemployment rate is expected to rise modestly to 3.8%. Average earnings are also not expected to falter, with month-on-month growth projected at 0.3% and year-on-year growth at 3.9%, compared to 4.0% previously.

(Source: FXStreet)

Will the market suddenly wake up?

Given investors' belief that the Fed will soon start cutting interest rates, a small swing in the headlines is unlikely to trigger an instinctive reaction in the dollar. A disappointing report is unlikely, as weekly jobless claims have been fairly low this month. So if there is anything shocking, it must be from an unexpectedly hot report.

The dollar is likely to move higher as yields rise, while Wall Street could be caught in a panic sell-off as investors taper their rate-cutting bets on the back of upbeat non-farm payrolls data. But if the jobs data fails to provide any new direction, investors could turn to other data released this week.

These include ISM manufacturing and non-manufacturing PMIs to be released on Wednesday and Friday, respectively, JOLTS job openings on Wednesday, Challenger company layoffs on Thursday, and factory orders on Friday.

The Canadian and Australian dollars face some risks

At the Canadian border, the Canadian dollar will keep a close eye on the domestic labour market, as the Bank of Canada's interest rate cut bet has also ramped up recently. By 2023, the Canadian dollar/dollar exchange rate is expected to gain about 2.5%, slightly outperforming other commodity-linked currencies, namely the Australian and New Zealand dollars. Less exposure to China and the Bank of Canada's undoubtedly tougher stance have led to a relatively outperformance against the Australian and New Zealand dollars.

However, if stagnant economic growth forces the Bank of Canada to start cutting interest rates, the Canadian dollar could face a tougher 2024. Published data projects that Canada's unemployment rate has been rising steadily since May and could rise further to 5.9 per cent in December.

(Source: FXStreet)

Although the number of jobs has been growing during this period, it has not been able to keep up with the growth in the number of job seekers. The economy is expected to add just 13,200 jobs in December. Despite this, wage growth remains high at 5.0%, so investors will also be watching this figure, as well as the latest Ivey PMI on Friday.

The PMI data is also important for the Aussie dollar as China is due to release two sets of PMI data next week. The official government survey will be released on Sunday and the Caixin/Standard & Poor's global version will be released on Tuesday. Any slowdown in China's December manufacturing PMI could hurt risk sentiment at the end of the year and start of the year, weighing on stocks and the Aussie dollar.

Eurozone inflation could reverse the trend

The euro is likely to take the middle of the forex rankings for 2023. The single currency has experienced some ups and downs over the past year, but overall it has been supported by a more hawkish than expected European Central Bank. However, by 2024, the weakness of the euro zone economy could prompt the European Central Bank to cut interest rates more than the Federal Reserve. However, the euro has emerged from the frenzied speculation of rate cuts as US Treasury yields have fallen faster than those in the eurozone.

Unlike the Fed, the ECB is cautious about signaling any turn until it is certain that inflation is indeed moving towards 2 per cent. Friday's preliminary December CPI reading is likely to justify this caution. The headline CPI is expected to accelerate from 2.4 per cent year-on-year to 3.0 per cent in December, suggesting there is still a long way to go before inflation continues to stabilize around the 2 per cent target.

(Source: FXStreet)

However, the forecast for the underlying measure of inflation is more encouraging, with the core consumer price index, which excludes food and energy, as well as tobacco and alcohol prices, expected to decline from 3.6% year-on-year to 3.4%.

If this is the case, investors are likely to keep their interest rate cut bets intact, meaning that a pick-up in headline inflation may not generate any additional boost for the EUR/USD.