Currency phoney war continues ahead of US payrolls & BoJ

Currency markets have mostly gone sideways this week, with the US dollar set to end it a touch weaker against most other major currencies. With both activity and price data continuing to surprise to the upside in the US, Europe and China, interest rate expectations have ratcheted up further as the “higher for longer” narrative takes hold. Indeed, money markets now appear to discount a substantial chance of both the Fed and the ECB stepping up the pace of their policy rate hikes in March (to 50bp and 75bp respectively). But rate differentials have not moved nearly as much and risk sentiment has weathered this year’s surge in yields much better than similar episodes in 2022. This has left currency markets see-sawing, waiting for a decisive catalyst in favour of one side or the other. An obvious candidate is next Friday’s US non-farm payrolls: the blockbuster January report sparked the beginning of the reassessment of rate expectations. A return to a more measured pace of jobs growth, in line with what we and most other forecasters anticipate, would probably take some steam out of the dollar’s rebound.