The dollar softens amid AI spend concerns
The dollar softened despite stronger US growth and inflation data as AI spending concerns drove a tech-led equity sell-off and Treasury yields lower.
USD
The dollar ended Thursday softer despite data that should have supported it. Q3 GDP rose at a 3.4% annualised pace against a 3.2% consensus, September PCE printed 0.5% MoM and 3.6% YoY with core steady at 3.1%, and initial claims fell to 194k, the lowest since July. None of this mattered against a tech-led equity sell-off, however, after Alphabet’s near-13% drop on AI spending worries, pushing investors into Treasuries. Two-year yields fell 6bp, 10-year yields slipped back below 5%, and December hike odds eased to around 75%, pushing the DXY index to just under 102. Still, with growth and core inflation both running above 3%, and Chair Warsh was clear that there is “no soft target”, our December hike call stands. That suggests some dollar upside on the horizon, yesterday’s price action notwithstanding. Today brings the Q3 employment cost index, Chicago PMI, month-end flows, and post-blackout remarks from Daly and Musalem. Given our view on the underlying macro, we would fade dollar weakness here.
EUR
The ECB held the deposit rate at 2.50% on Thursday, as expected, but the euro had a volatile session. EURUSD slid to near 1.11 immediately following the decision, before reversing to close near 1.12. Lagarde helped, confirming a hike was discussed and keeping December firmly in play, though she also noted tighter financing conditions and no serious second-round effects. Markets now price in roughly 22bp for December, although Lagarde’s early exit, scheduled for February, raises succession questions as French fiscal risk keeps the OAT-Bund spread above 150bp. None of this changes our view that a December hike offers little lasting support, and we continue to fade rallies with 1.11 the key level. Today’s focus is growth. French GDP has already disappointed, showing the economy shrinking in Q3. German figures follow at 09:00 GMT, and the eurozone print at 10:00 GMT is expected at 0.2% QoQ after 0.6% in Q2, though given data already seen, risks skew toward a weaker reading. After last week’s dire PMIs, that could prompt markets to trim December pricing, weighing on the single currency today. German October CPI at 13:00 GMT, expected at 3.0%, previews next Wednesday’s eurozone flash, with Brent near $115 the swing factor.
GBP
Sterling was a standout G10 performer again on Thursday, with GBPUSD climbing 0.5% and extending towards 1.34 overnight. Crucially, the Budget reaction has been benign, despite being broadly panned by most major news outlets. For now, markets have taken the £15bn of headroom and the deferral of major spending decisions in their stride. We remain wary of chasing this, however. The Budget left £30-50bn of spending pressures unaddressed, growth was cut to 1.0% for 2027, and inflation is forecast to average 3.4% next year, a mix that will eventually test gilts again. Nor is sterling insulated from the Middle East, where rising energy costs feed straight into household bills and the BoE’s inflation problem. Next Thursday’s MPC decision is 95% priced for a hike, so guidance will be key, and given recent indications, this should skew dovish relative to market pricing. With no UK data today, the pound will trade on the dollar and risk sentiment, meaning we see limited scope for gains beyond 1.34 before the BoE.
CAD
The loonie extended its post-BoC gains on Thursday, with USDCAD closing around the 1.40 level, holding there overnight. Wednesday’s 25bp hike to 2.50%, the first since July 2023, narrowed differentials at the margin, while a softer dollar did the rest. That said, we still think this hike was premature. Inflation excluding gasoline is just 2.2%, while the Bank’s preferred underlying measure sits below 2%, and payrolls have shrunk 110k in two months. In any case, that backdrop leaves the roughly 100bp of tightening priced over the next twelve months looking aggressive to us, and we continue to expect a December hold. Today’s August GDP print at 12:30 GMT, with consensus at 0.2% MoM after a flat July, is the first test. A soft report would support our view that rate pricing fades, and USDCAD drifts back towards 1.41-1.42.