FX Daily: Hold Your Horses

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USD: Dollar should stay bid on dips

As we have discussed, one of the main legacies of the war in Ukraine will be Russia's removal from global commodity supply chains. The cost of this is being borne out in global FX markets, where the energy, metal and mineral exporters continue to do well. The biggest mover in G10 FX over the last couple of days has been the Australian dollar - also getting a lift from a re-assessment of monetary policy. It seemed only a matter of months ago the Reserve Bank of Australia (RBA) was telling us that rates would be kept unchanged until 2024 and it would target the 2024 sovereign bond yield at 0.10%. The market now prices the first RBA hike in July and the 2024 bond trades with a yield near 1.40%!

But Thursday also saw the dollar broadly offered in a typical 'risk-on' move. There is a camp arguing that the dollar typically sells off in the first six months of a Fed tightening cycle - presumably on the 'buy-the-rumour, sell-the-fact' mentality of a well-telegraphed tightening cycle. What is different this time, in our opinion, is the aggressive front-loaded tightening about to be undertaken by the Fed and events in Ukraine which have damaged European growth prospects and will weigh on currencies in the region. 

In short, we suspect the dollar will stay bid on dips against European FX and the JPY, while the commodity-exporting currencies can continue to outperform. 

For today, the market will be looking out for any headlines from a Xi-Biden call and we would imagine investors would still be reluctant going into the weekend long risk assets. 

For choice, we see the 97.70/98.00 support area holding in DXY and would favour a move towards 100 into next week. 

EUR: ECB sprinkling commentary with some concern over the euro

Dutch central bank governor, Klaas Knot, was the latest member of the ECB to say that further EUR/USD weakness would be unwelcome as Europe deals with an energy supply shock. We suspect that EUR/USD will stay heavy this summer and that will probably end up dragging the ECB into a more hawkish position. (Knot said yesterday that he does not rule out two ECB rate hikes this year - the market currently prices a 44bp rise in the ECB deposit rate this year).

On the subject of EUR/USD staying weak, we'll be interested to see the eurozone January trade figures released at 11CET. The December 2021 figure showed a record monthly deficit of EUR9.6bn. Consensus expects a narrowing of the deficit to EUR9bn in January. But another blowout deficit should serve as a reminder that the eurozone's current account surplus - once the cornerstone of support for the euro - is under heavy pressure on energy imports. Indeed, we think the euro's medium-term fair value is now lower because of it. 

Yesterday's EUR/USD spike through 1.1100/1120 looked like a short squeeze and we would favour a drift back to 1.10 in these uncertain times.

GBP: BoE blinks

Unlike the Fed, the BoE delivered a cautious 25bp rate hike yesterday, with one dissenter voting for unchanged rates. The market removed roughly one 25bp hike from its expectations this year (Bank Rate now priced at 1.90% in December). GBP held up reasonably well - largely because the dollar was having a bad day and the view that if the BoE is worried about what the energy shock means for consumption, the ECB will be worried too.

Given we strongly favour the dollar this summer, levels near 1.32/33 in cable may be the best for some time. EUR/GBP stalled at 0.8450/80 resistance yesterday and we still prefer the pair trading back to 0.83. UK politics remains another wild card, where the Times is reporting that the UK government could fire up Article 16, suspending the Northern Ireland trade deal, after all. 

RUB: CBR to leave rates unchanged at 20%

The Central Bank of Russia (CBR) meets to set interest rates today. After its emergency hike to 20% to support the rouble, no change is expected today in policy settings. Instead, the focus will be on what the CBR thinks about the real economy and the financial sector.

The offshore USD/RUB is now being quoted at 102, while the onshore closed at 103.15 yesterday. Implied rouble yields through the FX swaps are being quoted markedly lower today, although we read that as a function of very illiquid markets rather than any dramatic improvement in market functioning.