Forex: Multiple moves on the FX chessboard

The US dollar index (DXY) saw a sharp uptick on Monday's, recouping part of the 1.7% dip it experienced last week. A cocktail of political drama and economic maneuvering fueled this resurgence. In France, political deadlock escalates as Marine Le Pen’s National Rally, now the powerhouse in the lower house, vows to dethrone the government following Prime Minister Michel Barnier’s bold move to sidestep a parliamentary vote to advance his 2025 budget. This turmoil saw the EURUSD tumble by 0.7%, while the spread between French and German 10-year yields stretched to 88 basis points.

Amidst this, Euro-area manufacturing slogs through a phase of contraction, with core economies like Germany, France, and Italy showing frailty. Over in the US, the ISM manufacturing index provided a silver lining, ticking up to 48.4 in November from 46.5 in October, though it still hovers in contraction territory.

The political upheaval in France is reaching a critical point, raising serious questions about its implications for the broader European landscape, especially during uncertain times in the US-European relations. Amid this turmoil, the broader eurozone contagion's potential remains a pressing concern. Yet, thus far, the fallout across European markets has been surprisingly contained. This resilience traces back to the European Central Bank's commitment, pledged under significant strain in 2012, to serve as a lender of last resort. This assurance still wields considerable influence over bond and currency markets, helping stabilize the region despite France’s political quagmire. This scenario underscores the ECB's pivotal role in maintaining financial stability across the eurozone amidst national crises.

Crossing over to Japan, BoJ Governor Ueda's signals for a potential rate hike this month have propelled Japan’s 2-year yield to a peak not seen since 2008, hitting 0.62%, while the 10-year yield edged up to 1.08%. This hawkish tilt bolstered the yen, nudging it below the 150.00 mark against the dollar, as traders navigate the rippling effects of Trump’s recent tariff threats on BRICS nations, further intensifying the global economic chess game.

China's bond market is sounding alarms, with yields plunging to historic lows, painting a dire picture reminiscent of Japan's protracted deflationary woes. The looming shadow of Donald Trump's potential return to office casts an unsettling pall over the scene, his aggressive trade rhetoric threatening to exacerbate China's economic struggles.

Amid this backdrop, the air is thick, anticipating further monetary easing by the People's Bank of China (PBoC). Despite a series of rate cuts and liquidity injections, the desired economic resurgence remains elusive, prompting speculation of even bolder measures on the horizon. Market chatter suggests potential cuts to the Reserve Requirement Ratio (RRR) or adjustments to repo and lending rates might be in play, as one-year swap rates have plummeted to a mere 1.53%—levels not seen since the early pandemic days.

This precarious financial scenario has triggered a surge in Chinese bond purchases, with traders eagerly leveraging up on bonds fueled by the easier monetary policy. This frenetic activity raises the spectre of a burgeoning bubble, putting the PBoC in the delicate position of tempering yields without triggering market upheaval.

It’s one of these perpetual doom loops for the Yuan; hence, FX traders are taking on the PBoC. 

Further compounding the economic drama, the stark rate disparity with the U.S. drags the yuan down to its weakest stance since July, intensifying pressures amid global currency fluctuations. With Trump's hawkish fiscal and trade stances poised to stir the pot, China faces an uphill battle to maintain currency stability while navigating the turbulent waters of global trade tensions. The swirling rumours of a potential yuan devaluation only thicken the plot as China grapples with the strategic dilemmas posed by an increasingly complex global economic landscape.

It’s pretty clear that when the yuan feels the heat, as it is now with CNH nudging the 7.3 mark, all eyes turn to the daily CNY fix for cues. Observers and traders await to see if Chinese authorities maintain their stance with a fix below the 7.2 level. This commitment could signal broader intentions regarding currency stabilization, or if they fix the above, perhaps a sign of letting the Yuan float a bit. This will have huge repercussions across Asia FX.

Today’s Fix came in at 7.1996 per US dollar, marking a 15-month low.