Weekly Currency Market Review and Outlook

US Dollar Performance and Market Drivers

Last week, the US dollar experienced significant weakness against nearly all G10 currencies, except the Swiss franc. The franc’s resilience appears linked to its usage as a funding currency rather than the Japanese yen. While Japanese authorities expressed concern over the yen’s rapid depreciation, Swiss policymakers seemed more amenable to the franc’s retreat against both the dollar and the euro.

The Mexican peso and Chinese yuan reached new highs for the year during the same period. Attention now shifts to the upcoming Federal Reserve meeting, the focal event of the week ahead. While three other G10 central banks—Reserve Bank of Australia (RBA), Swiss National Bank (SNB), and Bank of Canada (BoC)—are set to hold policy steady, market consensus strongly anticipates a Fed rate cut. This expectation has weighed on the dollar in advance of potential September and October easing, though past cuts have triggered subsequent dollar rallies.

Interest Rate Differentials

Three key interest rate spreads illuminate the US dollar’s dynamics:

– The US two-year yield premium over Germany has contracted to under 145 basis points, near its lowest level since September 2024. Earlier this year, in February, this spread peaked at approximately 225 basis points.
– The US 10-year yield advantage over Japan is at a 3.5-year trough, roughly 215 basis points, down from a January high slightly above 350 basis points.
– The US 10-year yield spread versus China, after reaching a record near 315 basis points earlier in the year, has narrowed by nearly 100 basis points.

While not asserting a direct one-to-one causality between interest differentials and dollar movements, these wide premiums have historically underpinned dollar strength. Furthermore, policy uncertainty emanating from Washington has increased investor risk premia on dollar assets.

Upcoming Economic Data and Fed Projections

Prior to the FOMC decision on December 10, the September JOLTS report and Q3 Employment Cost Index will be released, providing additional labor market insights. Alongside the rate decision, the Federal Reserve will update its economic projections. In September, median forecasts implied two rate cuts in 2026, with GDP growth anticipated at 1.8%, headline and core PCE inflation at 2.6%, and the unemployment rate at 4.4%. Current derivatives pricing suggests two cuts in 2026 with roughly a 60% probability of a third, factoring in a forthcoming transition in Fed leadership.

Dollar Index Technical Notes

The Dollar Index extended a downward trajectory through midweek, marking eight consecutive sessions of losses before stabilizing late in the week. Market participants remain cognizant of the dollar’s historical pattern of weakening before Fed cuts and recovering thereafter. The Index recently tested the 38.2% Fibonacci retracement from the September 17 Fed-day rally low. This technical level may prompt short covering, with initial resistance near 99.20 and subsequent resistance between 99.40 and 99.60.

Euro Area Overview

Euro as Dollar Alternative

The euro stands as the largest and most liquid alternative to the US dollar. The 30-day inverse correlation between euro price changes and US two-year and 10-year yield movements against Germany hovers around -0.40, while correlations with major equity indices (S&P 500, DAX, STOXX 600) are moderately positive.

German Economic Indicators

Key focus remains on Germany, with October factory orders outperforming expectations and industrial production and trade data scheduled for early this week. Industrial output may have increased in consecutive months for the first time since early 2024. German exports have grown modestly, averaging 0.1% per month through September, compared with declines in the prior calendar year. Imports have also risen steadily. The broader current account balance will be reported Friday, with consensus forecasting a reduction from 5.7% of GDP in 2024 to approximately 5.0% this year. The Bundesbank’s projection of a stable 5.7% surplus alongside next year appears optimistic compared to OECD estimates of a decline to 4.8% and 3.7%, respectively.

Euro Price Action

The euro’s eight-day rally ended on Thursday after briefly surpassing $1.1680, its highest level in nearly two months. It stalled below the 50% retracement of the declines since the Fed’s September 17 peak. The euro consolidated around $1.1635 heading into the weekend. A break below the $1.1580–$1.1600 range would be a negative signal, suggesting vulnerability ahead of the Fed meeting.

China and Yuan Dynamics

Policy and Currency Movements

The People’s Bank of China (PBOC) continues to lower the dollar’s daily reference rate, gradually facilitating yuan appreciation. Although the pace is slower than some critics prefer, the trend is clear. Market participants widely anticipate the yuan to approach the psychologically significant CNY 7.0 level. Notably, the dollar’s correlation with the offshore yuan has strengthened to approximately 0.70 over the past month, up from 0.40 a month prior.

Reserve and Inflation Data

Chinese foreign exchange reserves, rising consistently except for a dip in July, will be updated soon. Year-to-date through October, reserves increased by roughly $141 billion, offsetting a decline of nearly $36 billion in 2024. Reserve valuations are influenced by dollar movements against other reserve currencies, as well as China’s gold holdings, which have grown steadily amid a 60% year-to-date gold price surge.

While lending statistics may emerge next week, inflation data are key midweek releases. Deflationary headwinds are moderating; producer price inflation’s negative annual rate improved to -2.1% in October from June-July troughs near -3.6%. Consumer prices rose 0.2% year-over-year in October following two consecutive months of deflation. Bloomberg’s median forecast calls for a 0.7% CPI increase in November—the highest this year—matching last year’s peak. Core CPI in October stood at 1.2%, last registering below zero in February 2023.

Yuan Price Trends

After reaching a yearly low near CNH 7.0540 midweek, the dollar consolidated near CNH 7.0720 in the latter sessions. The decline from approximately CNH 7.1040 to CNH 7.0540 took over ten days, leaving ample time for potential further yuan strength toward CNY 7.0 before year-end. Market attention remains on the PBOC fixing for directional signals, which has been trending lower on a weekly basis since the end of Q3, except for a late-November anomaly.

Japanese Yen Update

Exchange Rate Drivers

The dollar-yen exchange rate continues to be influenced by broad dollar trends, although its 30-day correlation with the Dollar Index has fallen to around 0.60—the lowest in seven months. The yen’s movement shows moderate correlation with US two-year yield changes (~0.40) and weaker linkage to 10-year yields (~0.30). Despite rising long-term Japanese yields, the yen has not benefited; correlations even suggest higher Japanese yields correspond with a stronger dollar on a short-term basis.

BoJ Policy and Economic Data

Market-implied probability of a Bank of Japan rate hike by the December 19 meeting has increased sharply to about 90%, up from less than 60% at November’s end. The very low odds observed on November 21 (~15%) have dissipated amid evolving expectations. Although labor earnings remain a focal point for BoJ policymakers, the recent formal adoption by Rengo—the largest Japanese labor union—of a 5%+ wage increase target for the 2026 wage round may not significantly impact market sentiment.

Q3 GDP revisions are forthcoming, recalling that despite low interest rates, a weak currency, and a substantial fiscal deficit (approximately 3%), Japan’s economy contracted at an annualized rate of 1.8%. Net exports subtracted 0.2 percentage points from Q3 GDP. Early Q4 data indicate a tentative recovery, with a notable 1.4% industrial output increase in October (subject to revision).

Yen Price Developments

The dollar peaked near JPY 157.90 on November 20 and traded down to around JPY 154.35 before the weekend. Although the dollar recovered slightly back above JPY 155, the robust post-September 17 Fed cut rally appears concluded. The five-day moving average has crossed below the 20-day for the first time since early October, with the dollar settling beneath its 20-day average for three consecutive sessions. Short-term resistance is expected near JPY 155.60–70, followed by more significant resistance around JPY 156.50.

UK Sterling Market

Sensitivity to Dollar and Yield Movements

Sterling’s sensitivity to broad dollar fluctuations has slightly lessened from extreme inverse correlations near -0.90 in early October to approximately -0.80, though this remains high. Inverse correlations between sterling and the 10-year Gilt yield have moderated more substantially—from a five-year low near -0.73 to about -0.25. Similar trends exist with the US two-year yield, where the inverse correlation dropped from a 20-year extreme near -0.70 to around -0.35.

The UK government’s recent announcement of a tighter fiscal stance occurs alongside the Bank of England’s expected resumption of monetary policy easing—a combination typically supportive of sterling strength.

Key Data and Price Action

This week, housing market indicators will be released early, with Rightmove data showing year-over-year price declines for three consecutive months through November, while the Nationwide index registered a modest 1.8% increase—the smallest since June 2024. The October GDP release later in the week will be closely watched. Notably, Q2 and Q3 monthly GDP aggregates diverged from quarterly estimates, with consensus forecasts pointing to 0.2% growth in Q4.

Sterling peaked at $1.3385 on December 4, its highest since October 22, reaching the 50% retracement of losses since the September 17 high near $1.3725. The currency consolidated above $1.3320 into the weekend. The consolidation appears constructive; a move beyond $1.3400 may trigger a rapid rally of half a cent. Technical momentum indicators are stretched, with a break below $1.3280–$1.3300 signaling possible correction.

Canadian Dollar Overview

Correlation Shifts and Market Dynamics

The US dollar’s correlation with the Canadian dollar has waned. The 30-day correlation with the Dollar Index exceeded 0.80 in late August but fell to a nine-month trough around 0.30 in November, currently near 0.35. Since late May, the dollar tended to track US two-year yield movements in the same direction, yet recently this correlation has turned mostly inverse. Additionally, the USDCAD exchange exhibits a negative correlation (~ -0.35) with the US S&P 500, indicating risk sensitivity shifts.

The correlation between USDCAD and Canada’s two-year yields peaked near 0.50 in early October but has since inverted, currently about -0.45.

Bank of Canada Policy and Data

The Bank of Canada’s December 10 meeting is widely predicted to maintain the current policy rate. Market futures presently discount a possible hike only in late 2026. Due to the US government shutdown, Canada’s September merchandise trade data is delayed until December 11. Weakness in Canadian GDP this year is partly attributable to US trade disruptions. Notably, the January-August 2024 merchandise trade deficit expanded fivefold compared to the same period last year, increasing from approximately C$5.2 billion to over C$29 billion.

Price Movements

The Canadian dollar strengthened by roughly 0.7% against the US dollar ahead of the weekend, its largest single-day gain since late May, supported by a sharp unemployment rate decline (partially influenced by falling participation). USDCAD approached 1.3850, just above the 50% retracement of the rally since the year’s low near 1.3540 recorded June 16. Key retracement levels include 1.3840 (50%) and 1.3770 (61.8%). The rapid appreciation pushed the US dollar below its lower Bollinger Band, situated slightly above 1.3900, suggesting some caution.

Australian Dollar Developments

Correlation Patterns and Market Behavior

The Australian dollar’s sensitivity to the US dollar’s broad movement remains significant. Its rolling 30-day inverse correlation with the Dollar Index peaked near -0.85 in August, briefly flipping positive in November before returning to around -0.40. The 30-day correlation with the US two-year yield has fluctuated, reaching over 0.50 in mid-November—the highest since early 2020—currently near 0.20.

Correlations with the CRB commodity index have undergone multiple phase shifts across the year:

– January to February: Near zero,
– Late February to June: Positive, peaking above 0.70 in May,
– Late June to mid-September: Negative, hitting a low near -0.34 in July,
– October through November: Positive again, peaking near 0.54.

The current correlation stands near 0.32.

Policy and Data Outlook

The Reserve Bank of Australia meets on December 9 with no anticipated change in policy. Futures markets suggest roughly a 40% chance of a rate hike by year-end 2025. November labor market data will be reported December 11, following a cumulative 160,000 net new jobs created through October in 2024, with approximately 143,000 full-time positions. The unemployment rate stabilized at 4.3% after a brief September spike.

Currency Performance

The Australian dollar was the top G10 currency performer last week, gaining approximately 1.2% versus the US dollar, and rising around 2.7% over the past two weeks. The AUD approached $0.6650, a level unseen since September 18. The year-to-date high remains just above $0.6705 (September 17). Momentum indicators are stretched, with the currency finishing last week above its upper Bollinger Band (~$0.6625), suggesting potential short-term vulnerability. Support is expected in the $0.6585–$0.6600 range.

Mexican Peso Analysis

Correlation and Risk Sensitivity

Since late October, the peso’s correlation with overall US dollar movements weakened considerably before recovering to approximately 0.40. The peso tends to be sensitive to global risk appetite; its inverse correlation with the S&P 500 reached a yearly low near -0.75 in mid-October and has eased to around -0.35 recently.

The 30-day rolling correlation between changes in the US two-year yield and the dollar against the peso is slightly negative (~ -0.12), displaying a complex relationship over the past year. The peso’s relative attractiveness for carry trades is supported by favorable carry and volatility characteristics.

Inflation and Industrial Data

Mexico’s central bank meeting is scheduled for December 18. Ahead of this, November CPI data (due December 9) are closely watched. October headline inflation stood at 3.57%, core inflation at 4.28%, both within the 3% ±1% target range. Early November figures suggest continued firm inflation pressure. Industrial production has contracted for four consecutive months through September, contributing to a slight Q3 economic contraction of 0.3%. Rising recession concerns underpin market expectations of further rate easing.

Peso Price Movements

The peso surpassed previous yearly lows recently, reaching near MXN 18.1525, before stabilizing just below prior lows (~18.20). The US dollar briefly breached the lower Bollinger Band (~18.1930), settling slightly above. Technical retracement levels include MXN 18.18 (61.8% retracement of the April 2024 rally) and psychological support is noted around MXN 18.00. Further support zones may exist near MXN 17.60.

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_Disclaimer: This report is for informational purposes and should not be construed as investment advice._