The rise in back-end yields has prompted a risk-off environment that favors a consolidation of recent dollar gains. Markets remain reluctant to price in any optimism into oil prices, which keeps risks on the upside for rates. EUR/USD may still have some room to fall before recovering.
The dollar is benefiting from the knock-on effects of the bond sell-off on global risk sentiment.
USD: Keeping an eye on the back-end
The global bond sell-off continues to leave its mark on FX. The dollar is benefiting from the knock-on effect on global risk sentiment, allowing a consolidation of recent gains even as they start to look stretched relative to short-term fundamentals. Oil prices remain bid after the UN summit failed to generate tangible optimism about a resolution in the Gulf.
Reports that the US and Iran are discussing a phased deal to reopen the Strait of Hormuz prompted a correction in oil, but losses were fully recouped within a couple of hours, underlining growing scepticism about any imminent de-escalation. It is a dynamic that argues against any material rebound in bonds for now.
By extension, we remain cautious about calling the end of this USD rally. We may see $110/bbl for Brent before the end of the month, with the dollar finding fresh support from the energy story, especially in an environment where the Fed's hawkish remarks are allowing markets to price in more rate hikes. A testament to that is the 2-year SOFR, which is up almost 20bp over the past 48 hours. Pricing for October has now reached 18bp, with two hikes fully priced in by January and almost four by July 2027.
EUR: France a rising concern
We still view the 1.1320-1.1330 area as the next key support for EUR/USD. We could reach that level quite quickly if oil prices take another sharp leg higher and/or US data surprises to the upside over the next couple of weeks. For now, we do not think new lows are imminent, but downside risks persist.
As for euro-specific drivers, economic resilience (yesterday’s Ifo index mirrored strong PMIs) is at least partly being offset as a EUR-positive factor by wider eurozone spreads. French 10-year yields are trading 110bp above bunds, and there has been little relief from reports that Marine Le Pen may back the proposed budget to avert a bond crisis.
We analysed France’s fiscal issues in this note. Risks are tilted towards further spread widening from here, and while the FX impact remains difficult to isolate, it is a narrative that is unlikely to help the euro in the current environment.
CHF: SNB leaves hawks disappointed
The Swiss National Bank held rates unchanged as expected but surprised markets on the dovish side yesterday. Despite the upward revision to its inflation projections, policymakers signalled no concerns about second-round effects, with the price shock still viewed as temporary.
The SNB slightly tweaked its currency stance, removing the reference to an "increased willingness" to intervene while retaining its commitment to act when necessary. While this grabbed headlines, it is merely an adjustment reflecting the franc’s recent weakness and does not imply any reluctance to intervene again should the currency appreciate.
Market pricing remains too hawkish in our view, and that is what matters most for the Swiss franc. A hike is already fully priced in by March, but we still see few reasons to tighten policy in the foreseeable future. We think downside risks remain for the franc, with EUR/CHF potentially retesting the 0.9480 highs seen earlier in September. USD/CHF is probably where the upside potential is even greater at this point: an October hike from the Federal Reserve could prompt a rally to 0.85 in the near term.
CEE: Energy shock pushes tightening bets to new highs
Regional markets remain under pressure as volatility in core rates and energy prices amplifies moves in CEE rates. At the peak, markets priced in an average of 15bp of additional tightening across the region. Despite a partial correction, rates remain elevated, leaving roughly 125bp of tightening priced in for both Poland and the Czech Republic. High oil and gas prices at yesterday’s close, alongside fresh highs in 10-year US Treasury yields, point to continued stress today. Although the backdrop is not directly comparable with the 2022 energy shock, the market response is beginning to look similar. With peak tightening expectations in 2022 reaching 210bp in Poland and 165bp in the Czech Republic, further repricing cannot be ruled out if energy prices continue to rise, regardless of central bank rhetoric.
Yesterday, regional FX found support from improving rate differentials, reversing the narrowing trend in place since early September. This should help to stabilise currencies a bit. However, EUR/USD continues to test new lows and energy prices remain on the rise. Despite headlines suggesting possible US-Iran negotiations, we retain a bearish view on regional FX.
Comments
Log in or sign up to join the conversation.