FX Daily: Inflation Takes Center Stage as Geopolitical Events Have Limited Impact

FX Daily: Inflation remains the market’s priority

Events in Russia have had little discernible impact on the FX market so far. Instead, the hot topic of high inflation and what policymakers are prepared to do about it remains the market's priority. This will be at the top of the agenda at this week's ECB's annual symposium in Sintra. Expect another mixed week in FX markets and possible BoJ intervention.

 

USD: Geopolitics has yet to make its mark

Events in Russia this weekend have so far had very little impact on global financial markets. There has been no flight to quality rush into the short end of the US Treasury market (two-year yields are down only 2bp since Friday), crude oil failed to hold onto some very modest gains in Asia, and Asian equity price action was muted. In FX, it is hard to discern any flight to quality into the dollar, nor discernible outperformance of defensive currencies like the Japanese yen and the Swiss franc. The muted response probably reflects i) a lack of clarity over what comes next after this challenge to President Putin's authority and ii) financial markets having already experienced a year of a stronger dollar and higher energy prices after the Russian invasion of Ukraine.

 

Instead, the market is very much focused on inflation. Both central bankers and governments are under fire for having kept monetary and fiscal policy respectively too loose for too long. These (or at least monetary policy anyway) will be the hot topic for this week at the ECB annual symposium in Sintra. Many of the G7 central bank governors are in attendance and presumably will deliver a hawkish message, similar to the one that Federal Reserve Chair Jerome Powell delivered to Congress last week.

 

This means that yield curves look to remain very inverted as investors assess the degree of looming recession and that the dollar will stay strong against those currencies without a monetary defence – i.e., USD/JPY stays bid. In addition to Powell's comment at Sintra on Wednesday, the US highlight this week will be the release of the core PCE inflation data for May. This is released on Friday. Expected at 0.4% month-on-month, another high reading for core inflation suggests there can be no let-up in the Fed's hawkishness.

 

DXY can probably bounce around in a 102.00-103.00 range this week, while USD/JPY should edge closer to the 145 intervention zone.