Talking Points:

Pound to see greater volatility if PMI print tops forecasts vs. the alternative
US Dollar to rise as risk appetite sours if PCE data boosts Fed rates outlook
Australian, Canadian Dollar decline as prices correct after last week’s rally

The UK Manufacturing PMI report headlines the economic calendar in European trading hours. Consensus forecasts point to a slowdown that brings the pace of factory-sector activity growth to the lowest in four months. A soft print would fall in line with recent deterioration in BOE rate hike expectations.

In fact, futures markets suggest traders no longer expect the UK central bank to hike rates at all in 2016. The British Pound has been falling alongside measures of the 12-month policy view since mid-June 2015, hinting that much of the negative influence from this theme has already been reflected in the exchange rate.

With that in mind, a downtick on the PMI figure may have relatively muted implications for the price action. An upside surprise that clashes with the status quo and reignites BOE tightening bets could spark volatility however, sending Sterling higher. It may also undermine risk appetite, weighing on the sentiment-linked Australian and New Zealand Dollars.

A similar narrative emerges as traders look onward to the release of US PCE data. The Fed’s favored inflation gauge is due to show that the core price growth rate edged up to 1.4 percent in December, the highest since November 2014. As with the BOE, the recent dovish shift in Fed policy bets makes for asymmetric volatility risk should the number come out stronger than expected.

A strong result would clash with a 2016 view that has become dubious of the central bank’s ability to issue even one rate 25 bps hike, much less fulfill policymakers’ forecast for 100 bps in cumulative tightening. Even a modestly firm print may send the US Dollar broadly higher and trigger risk aversion, whereas a soft one could pass with relatively little fanfare.

Most major currencies consolidated in narrow ranges overnight. The Aussie and Canadian Dollars underperformed, correcting downward having been the best-supported currencies in the G10 FX space last week. AUD managed a brief bounce following a better-than-expected outcome on the Caixin China Manufacturing PMI report, but follow-through proved lacking.

This seems to make sense: the factory sector contracted once again, just at a slightly slower pace than analysts projected (48.4 vs. 48.1 forecast). The result was well within near-term trend averages however, offering little impetus for investors to rebalance exposure ahead of a busy docket of higher-profile event risk due later in the week.

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