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Interest rate outlook

The market sees the ECB as hawkish going forward but the Fed as dovish. Our view is the market is overestimating how high the ECB will raise rates and we don’t see a Fed dovish pivot.

In terms of the Fed we have CPI tomorrow - The rise in CPI will likely slow on a year-over-year basis, but the Fed has shifted its focus to the monthly readings due to base effects. We think October Core CPI to rise by 0.5% – pointing to inflation well above the Fed’s mandate

“Higher-than-expected inflation figures have been a trigger for a stronger USD (6 out of the last 10 CPI releases this year – see Chart 3) and that could easily be the case this week as well, especially when the data shows that financial actors are net short USD.” (NORDEA)

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On the other hand, the ECB can raise rates much due to the fact the economy is going into recession and hikes won't have much impact on energy prices which while they have fallen back in the short term will rise longer term

The Impact of Energy

Spot gas has fallen but looking forward it's not so good -The recent fall is due to mild weather in Europe (Germany was 3 degrees warmer in Oct vs 30 yr average). In terms of warmer weather 1 degree saves about 10bcm from heating demand in Europe. Current gas storage in Europe is high at over 90% and in Germany, it's at 99%. Demand has been curtailed, esp in Germany where industrial demand is 40% of total gas demand, and has fallen 20% in recent months. But as we enter winter, gas storage will fall hard and next winter looks challenging.

Replacing Russian gas is not a quick process and prices will remain elevated in the year ahead.

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The Economy

Leading indicators point to a recession is coming in the 4th quarter.

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Euro Zone Terms of trade current Account Falling 

Money euro zone spends out over capital inflows is expected to drag the euro lower.

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Sentiment - Speculators Heavily Long the EUR

In terms of sentiment, we have non-commercial speculators holding a net long position which is the biggest in over 1.5 years and this speculative position is vulnerable to being hit on stop.

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The interest rate outlook favors the USD and the US economy is far stronger than euro zones. Also, the USD is a safe haven and offers both yield and safety. 

Technical Analysis 

We have run up to major resistance and we are starting to fall back - if we take out the 1.000 level we expect a move down to support at 0.9600 as the large number of speculators who are long are taken out on stop.

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