FX Daily: Dollar bears will have to be patient

USD: FOMC minutes can keep the dollar supported

Despite Federal Reserve Chair Jerome Powell sounding quite relaxed at the 1 February press conference and declaring that the 'disinflation process has started', the minutes of that meeting were largely hawkish. The consensus agreed that further rate increases were needed and that inflation remained unacceptably high. There were no hints of a pause and very little to divert market pricing of three more 25bp hikes from the Fed over the March, May and June meetings.

This backdrop can keep the dollar supported in the near term and potentially into the 22 March FOMC meeting, where the debate will focus on whether the Fed Dot Plots will retain a median view of a 100bp easing cycle in 2024. For dollar bears, both activity and price data will have to soften over the coming weeks to make an impact on an otherwise hawkish Fed. The next set of meaningful US data is tomorrow's core PCE data for January - but even that is likely to see the core month-on-month reading rising to 0.4% from 0.3%. And for today, the market should not take too much notice of revisions to the strong fourth quarter GDP data -  driven by an inventory build and weaker imports.

Our first quarter game plan is that DXY does not hold onto these gains. But for the time being, it looks like DXY wants to probe higher to the 105.00 area with outside risks this quarter to the 106.00/106.50 area.

Chris Turner

EUR: PMIs drowned out by hawkish Fed

The better run of European PMIs earlier this week has rather been drowned out by the hawkish Fed. And actually, the German Ifo proved something of a reality check, where the current assessment of business conditions continued to deteriorate. The good news for EUR/USD is that the re-pricing of the European Central Bank cycle has nearly matched that of the Fed - meaning that the two-year EUR:USD swap differential has not substantially widened in favour of the dollar. In fact, it was interesting to read in the FOMC minutes - under the market developments section - that the Fed felt it was interest rate differentials and the improved Rest of World growth prospects that had been weighing on the dollar into January. These are the factors we have been using in our scenario analyses. 

For the short term, EUR/USD remains soggy and it is hard to rule out a break under 1.0600 towards the 1.05 area. Our game plan remains that 1.04/1.05 could now be some of the lowest EUR/USD levels of the year - but it feels like EUR/USD could trade on the offered side for a few weeks yet.

Chris  Turner

EUR/SEK has seemed to find support at the key 11.00 level for two consecutive sessions after rising bets on Riksbank tightening had put pressure on the pair. We could see a temporary break below 11.00, but our view is that a sustained SEK rally is premature. Our short-term fair value model shows how there is no risk premium left on EUR/SEK: in other words, markets have priced out the risk of a collapse in the housing market in Sweden and a consequent slump of the whole economy. While hawkish Riksbank rhetoric is helping the krona, markets may have moved too quickly on the optimistic side. Upcoming data may underpin the rising risks to the Swedish economy, and could trigger a rebound in EUR/SEK before a sustainable move below 11.00 can materialise - we think from the end of the second quarter onwards.

Francesco Pesole

GBP: BoE's Mann speaks today

Sterling is just about holding onto Tuesday's gains when strong PMI data triggered a sharp re-pricing of the Bank of England curve. Markets now price a further 50bp of BoE hikes by June - taking the Bank Rate to 4.50% - and the policy rate being kept there until early 2024. For today, the focus will be on a speech at 1030CET by the BoE's Catherine Mann. She speaks at the Resolution  Foundation on 'The results of rising rates: Expectations, lags and the transmission of monetary policy'. This sounds like it could be a dovish speech - i.e. let's pause and see what prior tightening has done. However, she is a hawk and with no clear signs of an easing in tight labour market conditions we doubt she will want to knock the current market pricing of the BoE cycle.

We think EUR/GBP probably traces out a 0.8750-0.9000 range for the first half of the year, while cable should find support under 1.20. Also - whisper it. Sterling offers quite attractive risk-adjusted yields in the G10 space.

Chris Turner

ZAR: Seeking alpha

There is much talk of 'stock-picking' or 'seeking alpha' this year as financial markets may no longer be purely risk on/risk off. In other words, local stories are having a greater bearing and that is certainly true in the EM FX space. We are no longer looking at the kind of homogeneous returns driven purely by the Fed/China story. 

Here we will quickly look at two topics. The first is that some emerging currencies are lagging as politicians start to resist high interest rates and question central bank independence. This has been a loose fear in Brazil with the new Lula administration questioning whether the central bank needs to lift its inflation target. The Brazilian real has lagged gains in EM FX this year and we expect it to continue underperforming.

More surprising have been events in Israel, where the Foreign Minister heavily criticised the central bank for hiking rates 50bp on Monday. Normally an outperformer, the Israel shekel was hit hard on the news and the Israeli government has spent the rest of the week trying to re-affirm the independence of the central bank. We like the shekel and see USD/ILS trading back to 3.30/3,40 later this year. But we will now have to watch political developments closely.

Meanwhile, the South African government yesterday announced a major financial support plan for state utility, Eskom. The plan has been greeted well by Eskom bondholders, though the support means South Africa's sovereign debt to GDP profile deteriorates. The South African rand has been an underperformer this year and near 8% implied yields through the three-month forwards and the China recovery story have not been enough to provide support. We think investors will continue to pause for thought before chasing yields in the rand.

For those investors wanting to take exposure in EM FX, we continue to think the Mexican peso remains attractive. It has one of the highest risk-adjusted yields in the EM FX space (implied yields corrected by implied volatility from the FX options market) and the Mexican sovereign trades on a narrower CDS than most after Mexico refused to add on debt during the pandemic. USD/MXN looks biased to the 18.00 area.

Chris Turner