FX Daily: Dollar Softness Looks Unlikely To Last

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We think that lingering Russia-related downside risk for sentiment and upside risk for commodity prices continue to warrant a stronger dollar and weaker European currencies. Accordingly, the balance of risks for EUR/USD remains skewed to the downside in our view, and we expect a drop to 1.08-1.09 in the coming weeks

USD: Most factors still point to a stronger dollar

The dollar is approaching the end of the week on a softer note, with some overnight adjustments that saw USD/JPY correct lower before finding some fresh buying interest (we still think higher yields point to 125 in the coming days), and yet another leg higher in the antipodeans (AUD and NZD). The two currencies continue to benefit from being geographically far from Ukraine’s conflict while benefiting from higher global commodity prices.

Natural gas prices have stabilized after the rally induced by Putin’s decision to ask “unfriendly countries” for rouble payments on energy exports, and so did crude after some speculation that the EU may curb imports of Russian oil proved unfounded. Still, the US and its allies have repeatedly warned that Russia may escalate the current conflict with a variety of different weapons, and Putin appears quite determined to use an unexpected range of tools to counter-sanctions. too. All this continues to signal significant upside risks for commodity prices and downside risks for risk sentiment: in FX, markets may find the current levels as relatively attractive to build back some defensive long-USD positions, mostly against European currencies.

We also think that a market that is inching closer to pricing in 100bp of rate hikes by the Federal Reserve at the next two meetings may favor the dollar. Today – amid a very quiet US data calendar – we’ll hear from FOMC members Mary Daly, John Williams, Tom Barkin, and Christopher Waller.

EUR: Not enough bullish steam

EUR/USD benefited from some dollar softness to climb back above 1.1000 overnight, although we have seen in the past few days how the pair is struggling to find enough bullish support to extend the run to 1.1100. We think this can continue being the case today – and that the combination of lingering Russia-related risks, high energy prices, and Fed-ECB policy divergence still points to a weaker, rather than stronger, EUR/USD. We continue to expect a drop to 1.0800-1.0900 in the coming weeks.

On the data side, we’ll take a look at the German Ifo survey, after PMIs released yesterday showed a less pronounced slowdown than feared, likely leaving the market’s assessment of stagflation risks in the eurozone on hold for now. There are no ECB speakers scheduled for today after a very busy week in terms of central bank informal communication, which seemed to have little impact on the euro.

GBP: Stabilizing

UK services PMIs surprisingly advanced in yesterday’s reading, largely offsetting the drop in the manufacturing gauge, and showing an overall still-contained impact from the Ukraine war on activity. This morning’s UK retail sales data from February came in slightly below consensus, showing a larger deceleration than expected, but had a negligible market impact.

EUR/GBP has climbed back to the middle of the 0.83-0.84 range after having failed to decisively break below the 0.8300 support earlier this week. Still, the euro’s higher exposure to Russia-related and commodity-related risks warrant a break below the 0.8300 level in the near term, in our view.

Cable seems, for now, stuck at the 1.3200 after having briefly traded around 1.3300 again. Some support to the dollar may put some pressure on the pair in the coming days but there may not be enough bearish push to send it below 1.3000.

NOK: Norges Bank's hawkishness helps the case for weaker EUR/NOK

The FX reaction to yesterday’s Norges Bank meeting was slightly negative for the krone, likely on the back of some “sell-the-fact” approach given the currencies had rallied into the meeting also on the back of bets around an upgrade in the rate-path forecasts.

As discussed in our Norges Bank meeting review, the 25bp hike and pledge to hike again in June was accompanied by a sizeable hawkish revision in rate projections, with a terminal rate now seen at 2.5% in 2023. Indeed, Norges Bank has been highly reliable in matching its rate projections with actual tightening, and the positive terms of trade shock along with rising domestic inflation leave little doubt that NB will follow through on its upgraded rate path.

NB’s hawkishness – paired with instability in the Russia-Ukraine situation which could continue to push energy prices higher – points to more EUR/NOK weakness in the coming weeks, in our view, and we expect a decisive break below 9.50 very soon, with room for a move to the 9.30-9.40 region.