FX Daily: Question Time

USD: All eyes on Powell

The dollar started the week tracking the swings in US Treasury yields, struggling to hold on to yesterday’s afternoon gains as 10Y UST seemed to find some buyers around the 1.80% level. We expect any dollar dips to be short-lived as the imminent Fed tightening story continues to offer a very positive undercurrent for the greenback.

Photo by Mufid Majnun on Unsplash

At the same time, a sizeable break higher in the already overbought USD has lacked a clear catalyst: today’s first Senate hearing of Fed Chair Jerome Powell might be the trigger for some out-of-range move. In a pre-prepared statement, Powell asserted that the Fed would not allow inflation to take root in the economy, but Senators will likely try to extrapolate a more detailed plan on how the Fed plans to fight rising prices. At the same time, a lot of focus will be on themes other than monetary policy, such as banking regulation, climate change and the trading scandal that led Vice Chair Richard Clarida to resign before the end of his mandate.

With markets flirting with the idea of four rate hikes (three and a half are already priced in) in 2022 and with a market-implied terminal rate now around 1.75%, the bar for a hawkish surprise is not low. Still, we think that an acknowledgement that faster rate hikes are needed could be enough to offer more support to the dollar today as investors cement expectations around 100bp of tightening in 2022. Expect markets to be particularly sensitive to any discussion on the reduction of the Fed's balance sheet, a topic that became particularly hot after the December FOMC minutes and may cause further fragility in the bond market (and offer more support to the dollar) down the road.

Any Powell-induced dollar strength would normally be channeled through weaker low-yielding FX, although the current soft environment for equities may also continue to weigh on the pro-cyclical sector – leaving the dollar itself as the only potential winner from the Fed’s hawkish message.

EUR: Sliding towards the lower-end of the range?

EUR/USD seems to be finding some support around the 1.1300 level, although hawkish remarks by Powell today may trigger a break lower. We think EUR/USD can soon move to the lower-end of its 1.1240/1.1380 December/January range.

There are no clear domestic drivers for the EUR at the moment, with the dollar/risk sentiment swings dominating in the EUR/USD price action. Some focus should only remain on ECB speakers for now. Today, keep an eye on the Bundesbank handover ceremony: a chance to gauge the views of new president Joachim Nagel on inflation and monetary policy.

GBP: Showing resilience

It’s all quiet in the UK data calendar, but GBP has remained quite strong in the crosses at the start of this week. We continue to favour a move lower in EUR/GBP (to the 0.8270/80 area) in the near term, and good GDP figures should offer further help on Friday.

CHF: Under pressure, but keep an eye on Italian politics

Swiss National Bank sight deposit figures for the first week of January suggest the Bank has increased FX intervention to weaken the franc at the start of the year. The Omicron crisis added fuel to a CHF bullish run that started in September and pressured EUR/CHF into the 1.03/1.04 at the start of January. The franc experienced a big long-squeeze yesterday, with SNB intervention likely adding pressure to CHF and markets rotating to the other safe-haven – the quite oversold JPY – as equities tumbled.

Outflows from the CHF may continue today if Powell sends hawkish signals to the market and UST yields rise again, assisting a more decisive break above 1.0500 in EUR/CHF. However, it’s worth keeping an eye on Italian politics in January, as major parties are set to discuss potential candidates– including current Prime Minister Mario Draghi – this week for the role of President of the Republic, who is set to be elected by parliament in late January. CHF is the quintessential FX hedge to Italian political risk, and any impact on the already widening BTP-Bund spread might soon put a cap on the EUR/CHF rally.