What are the Five Currency Pairs to Watch in December and Why?

It’s going to be a fascinating end to the year in financial markets, with central banks once again at the forefront of it. Interest rate decisions, economic forecasts and press conferences will set the stage for the first quarter of 2024 and beyond but before we get to that, there are some notable economic releases to come first that may have a big role to play in how central banks position themselves.

With that in mind, here are five currency pairs to look out for this month as part of your forex trading watchlist.

The European Central Bank is expected to leave interest rates unchanged again on 14 December as policymakers welcome inflation data that shows price pressures have eased considerably and worry that it has come at a significant cost to the economy. With Germany perhaps already back in recession and others arguably not far behind, the next challenge for the central bank will be returning price growth to target without inflicting unnecessary damage on an already fragile economy.

The ECB will also release new economic forecasts alongside their decision which will be interesting as policymakers have stuck with the higher for longer narrative until now, even as markets have priced in the first cut in June. If that’s going to happen, even with a late pivot, that doesn’t leave the central bank long to adopt a more balanced tone, with March forecasts then opening the door – should the data allow – to the pivot.

EUR/USD has rebounded over the last month as markets have increasingly priced in the end of Fed tightening and an earlier rate cut in 2024. It saw some resistance around 1.10 at the end of November, which could be a psychological hurdle for the pair.

While we can talk about other central banks, it’s the US that’s really going to set the tone for the end of the year and the start of 2024. The Federal Reserve meeting on December 13 is the headline act and may well determine how we end the year. But there’s plenty to come before then that will influence whether policymakers can accept the tightening cycle is over and allow investors to dream of a world of lower rates next year.

The US jobs report on December 8 could set the tone for the month. While getting inflation back to 2% is the primary goal of the Fed, it’s clear that policymakers currently think it can’t be sustainably achieved if the labor market remains hot. Another weaker report could convince policymakers that high rates are taking their toll and no more is likely needed, setting them up to start considering rate cuts next year.

The final CPI inflation report of the year lands the day before the Fed meeting and could sway the FOMC one way or another. We’ve seen substantial progress on inflation, but at 3.2% (core 4%), it’s still well above the 2% target. Another big step in the right direction is likely needed to convince the Fed that it’s defeated inflation.

It’s not a quiet month from a UK perspective either. The Bank of England will announce its interest rate decision before the next inflation report, though, so as far as that is concerned, there will be no late surprises. It will follow jobs and GDP data, though, which could point to a further slowdown in the economy under the weight of high interest rates.

Expectations for the first BoE rate cut have been pushed back to August recently, aligning with its summer Monetary Policy Report. We won’t get one of those in December, as the quarterly timetable is different from that of the Fed and ECB. So there may not be quite the same fireworks, but there’ll still be huge interest.

A weaker dollar has enabled GBP/USD to bounce back in November to hit three-month highs. Whether it’s able to capitalize on the recent moves may depend on the outcome of the two central bank meetings.

The next move in interest rates is likely to be a cut, according to financial markets, with the drop in inflation in October to 4.9% from 5.6% in September – much faster than anticipated – enough to convince investors that the RBA is done with its tightening cycle. That’s despite Governor Michele Bullock highlighting stronger demand a day earlier as a reason to be vigilant, with services inflation particularly sticky. While that may be true, the October decline makes another rate hike on December 5 much less likely after the RBA ended a four-month pause in November.

GDP and labor market figures follow over the next couple of weeks before we get the minutes of the meeting on the 19th.

AUD/USD has performed well in the second half of November, reaching a four-month high in the process.

Markets are convinced that the Bank of Canada is done raising interest rates, with the first cut coming as early as March. It’s easy to see why: inflation has fallen to 3.1% in October, and higher rates have pushed up the rate of unemployment from 5% to 5.7% since April. Meanwhile, the economy has basically flatlined for much of the year, but a recession looks to have been avoided for now. A soft landing may well be on the cards.

USD/CAD has pulled off its highs in November, but it’s yet to gather any significant momentum, perhaps due to markets pricing in an earlier rate cut from the BoC than the Fed. Still, the pair fell to a two-month low on the back of broad USD weakness.

Pressure on the Japanese Ministry of Finance to intervene in the FX markets has eased recently, with the yen rebounding strongly against the dollar in the second half of November. Traders will still be on high alert, though, for the possibility of another move.

And it’s not only intervention that traders have to think about, with pressure mounting on the BoJ to further tweak its yield curve control policy tool and even lift interest rates out of negative territory amid higher inflationary pressures. They may not do so when they meet on December 19, but markets are anticipating a rise in interest rates around the middle of next year. What the BoJ says on interest rates and yield curve control will be closely monitored, as will inflation data earlier in the month.

USD/JPY has eased off its highs recently, having repeatedly breached 150, triggering intervention speculation and appearing to make traders nervous. A move back in that direction could see nerves return going into year-end.