Although the Polish currency spent most of the week on the ropes, it strengthened dramatically toward the end, finishing the week higher. While a slight improvement in the external environment certainly did not hurt, we primarily attribute the appreciation of the zloty to reports suggesting that the payment of EU funds to Poland is getting closer.
The main bearish stimulus and the most important global theme in currency markets was the market’s deferral of implied expectations for the initiation of interest rate cuts in the United States. We have long emphasized our view that investors are rushing to price in interest rate cuts by central banks, particularly by the Federal Reserve. Last week further confirmed this – the strength of US economic data continues to surprise markets, and Federal Open Market Committee officials are pushing back expectations for rapid cuts. The base market scenario is no longer a cut in March – its pricing has fallen to the year’s lowest level of 40%. This change contributes to the appreciation of the dollar – the US currency is performing best out of all G10 currencies in 2024.
This week we will focus on macroeconomic data and the European Central Bank’s meeting (Thursday, 25th Jan). On Wednesday (24th Jan), we will learn the preliminary readings of January PMI indicators from the major economies – these are particularly important for the eurozone, where there is a lack of other credible current data. Other important readings will be Q4 GDP (Thursday, 25th Jan) and US December PCE inflation (Friday, 26th Jan). We believe that overall positive data will allow central banks to further postpone expectations for early interest rate cuts.
Last week was like a roller coaster ride for the zloty – initially, it experienced a sell-off to the lowest level in two months against the euro, only to make up for losses with interest on Friday. We attribute the weakness of the currency to global factors – the renewed rise in US bond yields led to a significant drop in EUR/USD pair. The strength of the zloty, on the other hand, can be justified by signals related to the payment of EU funds. The EU Commissioner for Justice, Didier Reynders, spoke optimistically about the prospects for unblocking money from the KPO for Poland. What’s more, according to the Minister for Funds and Regional Policy, Katarzyna Pełczyńska-Nałęcz, the government has already received confirmation that it will gain access to 76.5 billion EUR from the EU Cohesion Fund. Last week, the “Financial Times” suggested in one of the articles that the Polish government, in cooperation with the EU, might be able to find a solution that would bypass the potential presidential blockade of reforms necessary to unfreeze funds. Investors are gaining faith in the payment of EU funds, which strengthens the zloty.
Industrial production in the eurozone remains weak, which can be partly attributed to China’s unimpressive economic activity. Last week’s reading for November showed that production shrank by almost 7% year-on-year, thus pulling economy into a technical recession. However, ECB officials continue to push back market expectations of aggressive and rapid interest rate cuts. They suggest that the bank has not yet won the fight against inflation and that cuts should wait until summer.
Thursday’s (25th Jan) ECB meeting gives the bank a chance to clarify its stance and specify what readings it expects in order to decide on the first cuts. We believe that the bank will again strike a rather hawkish tone, arguing that it is not yet time to start thinking about cuts. We can also expect more blunt comments from President Christine Lagarde, who last week gave the impression that she does not expect the bank to start easing its policy before the summer arrives.
A series of second-tier data (retail sales, industrial production, or the number of new jobless claims) exceeded economists’ expectations, emphasizing the ongoing strength of the US economy. The labor market is doing particularly well – last week’s number of initial jobless claims was not only much lower than expected, but also the lowest since September 2022. Therefore, it’s no surprise that US bond yields are rising and the dollar is making up for last year’s losses.
Forthcoming data this week – PMI (24th Jan), GDP (25th Jan), and the Fed’s preferred PCE inflation measure (26th Jan) – may help to clarify the situation, but are unlikely to significantly change the rhetoric presented by the central bank’s decision-makers in recent times. They are trying to emphasize in their statements that market expectations for interest rate cuts remain overly aggressive. We expect next week’s FOMC meeting to further push them back, which should almost rule out the initiation of rate cuts in March.
Both inflation measures were significantly higher than expected in December – this divergence was especially notable in the case of the core measure, which still exceeds 5%. This suggests that the home stretch in the fight against inflation will be the most difficult to overcome in the UK, as in other countries. This is leading investors to lower their expectations for the Bank of England’s rate cuts.
Investors are losing sleep over the fairly fragile state of the UK economy. The retail sales reading published last Friday was exceptionally weak – it recorded the biggest monthly drop since 2021 when pandemic restrictions were still in place. In mid-February, the official Q4 GDP reading will be published, which will confirm or rule out a technical recession. If we believe last week’s data, it is more probable that it cannot be avoided. PMI readings (Wednesday, 24th Jan) should be much more positive and point to expansion, which would support the pound.
Authors: Enrique Diaz-Alvarez, Matthew Ryan, Roman Ziruk, Itsaso Apezteguia, Michał Jóźwiak – Ebury analysts.
