The ECB should keep rates on hold today, but we think policymakers will focus on preserving the hawkish market pricing. We suspect the now familiar post-meeting data leak will signal a September rate hike. That may keep EUR/USD supported from a rate perspective, delaying a break lower. In Australia, blowout jobs numbers are helping the bullish AUD case.
USD: Risks remain on the upside
Broad FX volatility has stayed subdued this week. Higher oil prices are not yet delivering the deterioration in global risk sentiment needed for the dollar to fully benefit from the current backdrop, and the hawkish repricing in central bank expectations in the rest of the world is capping the pass-through from rising front-end US rates to the dollar.
As a result, FX investors continue to favour high-yielding commodity currencies. Brazil's real, South Africa's rand and the Mexican peso have been among the strongest performers this week, while Norway's krone has led within G10.
That said, we remain cautious. The low-vol regime carries material risks should risk assets reach a breaking point in their tolerance for higher energy prices. That point may be nearer than current market calm implies. In our view, the next 10 days will need to deliver some path towards a renewed ceasefire, or the dollar’s short-term upside risks could increase rapidly. Overnight, Houthi militants attacked two Saudi ships in the Red Sea, adding a further potential source of supply disruption.
Today, the European Central Bank will attract most of the headlines in the macro space, while the US calendar remains rather quiet. As we expect a hawkish vibe from Frankfurt (more below), DXY may need to wait a bit longer to find its way back to 101.50.
EUR: ECB to stay hawkish
The ECB is widely expected to leave rates unchanged today, but as Carsten Brzeski explains here, a surprise hike cannot be fully ruled out. As usual, our cheat sheet lays out four possible meeting outcomes.
Our baseline is a hawkish hold. The re-escalation in the Middle East and European gas prices rising faster than oil prices should keep hawkish voices dominant in the governing council, in our view. The aim today could be – once again – to preserve market pricing (45bp by year-end) to limit the risk of inflation expectations de-anchoring. Achieving that may well require some indication that a September hike remains in play – more likely through a familiar post-meeting media leak than directly in the press conference.
Admittedly, the hawkish bar set by the market via pricing isn’t low, but we think the scenario above should be enough to limit the downside for front-end rates and, by extension, the euro. A central bank meeting would normally be a prime catalyst for EUR/USD to break out of its tight trading range, but we do not expect that to happen today. Our near-term bias remains tilted to the downside, as we believe FX markets are dangerously complacent about developments in the Gulf. Unless the newsflow becomes more constructive, we look for EUR/USD to slip towards 1.1380 in the coming days.
AUD: Strong jobs figures offer good support
Australia posted some very strong jobs numbers for June this morning. Employment jumped 76k (consensus was 15k), and unemployment stayed at 4.4% despite the rise in the participation rate. May’s figures were also revised slightly higher, signalling a total of 120k job gains over two months.
This is a rather strong hawkish signal for the Reserve Bank of Australia. The return of high energy prices is likely causing fresh concerns on the inflation side, and this surprising tightness in the labour market raises the risk of second round effects. Markets are understandably pricing back a rate hike by year-end, and we see some additional short-term upward potential for front-end AUD rates. The 11 August meeting is more likely to deliver a hold, but the chance of a new hawkish tilt is increasing rapidly.
We have been optimistic about a new round of AUD strength. While we cannot ignore the risk of a break in sentiment, a resurgence in FX volatility and a hit to high-beta currencies like the Australian dollar, Australia's terms of trade are improving again. Together with the currency's relatively high yield, that should provide a more lasting source of support for the Aussie dollar. We still target 0.73 for year-end for AUD/USD.
TRY: Delaying restart of easing keeps carry attractive
The Central Bank of Turkey is likely to leave rates unchanged at 37.00% today. The policy outlook has shifted in recent days, both because of geopolitical tensions which have pushed oil prices above $90/bbl, and a decision to gradually unwind a sliding scale tariff mechanism, which reduces the room to absorb the impact of higher oil prices, despite measured regulated price hikes. This backdrop will likely lead the central bank to be more cautious in easing liquidity conditions. While markets see some chance of the CBT restarting one-week repo auctions at 37% today, we expect funding to remain at the upper end of the corridor for an extended period. We also expect hawkish guidance, with the CBT stressing a meeting-by-meeting approach rather than opening the door to a rate-cutting cycle.
The rates market has seen only a little repricing with the re-escalation of the US-Iran conflict compared to previous months. The market is roughly pricing in a reduction in the effective rate to 38.50% today and matching the key rate from October this year. Although we do not expect a restart of auctions at today's meeting, we expect the CBT to return to rate cuts in 4Q, taking rates to 35.00% at the end of the year.
On the FX side, the situation looks more optimistic with the CBT accumulating reserves in recent weeks and at the same time essentially returning long positions in the TRY market to previous highs. The market clearly agrees with our view that despite the thinning carry, TRY remains an attractive currency, which is unlikely to change in the near future.
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