FX Daily: Setting The Scene For A Dollar Rebound

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This morning's reports of a cease-fire violation in Ukraine and a lack of confirmation that Moscow has withdrawn its troops are helping the dollar and safe-havens find some support. A quick diplomatic solution is looking less likely now and, when adding the support offered by Fed hikes front-loading, we think the bearish-USD run has lost most of its steam.

USD: Reduced downside risks

FX was the only segment that saw a significant improvement in risk/geopolitical sentiment yesterday. Bond yields inched lower, equities struggled to stage gains, and oil (which is negatively correlated to Russia-Ukraine tensions) was supported until news of an imminent Iranian nuclear deal sent prices lower.

The dollar remained offered yesterday, although the bearish run is starting to look a bit tired. In particular, we see an increasingly high probability that the Russia-Ukraine situation will not take any clear direction in the next few days and may morph into a longer diplomatic game – with some degree of diplomatic risk that may linger across asset prices for longer. This morning, safe-haven currencies jumped after Russian-backed separatists claimed that Ukrainian forces have violated the cease-fire, while US sources continue to deny that Moscow has actually started to withdraw its troops. The dollar could find some support until we get more clarity on this.

Another reason why the dollar downside risks look limited is the ongoing speculation around front-loading of Fed tightening. Even if the minutes of the January FOMC meeting showed nothing more than a well-telegraphed alarm over high inflation – but few indications around the pace of rate hikes – markets are proving reluctant to price out a 50bp March hike (which currently has a 50% implied probability). This should continue to offer some support to the dollar in the dips, and 95.50 could again be the floor for DXY in the case of another round of USD selling. Still, we think it is more likely USD will find some stabilization/support today.

Today, the US calendar includes housing data and jobless claims, and we’ll hear from Fed’s Bullard (an advocate for fast tightening) and Mester. Russia-Ukraine tensions will remain the key driver for markets.

EUR: More ECB speakers, less FX impact

EUR/USD was rejected at the 1.1400 level yesterday, a resistance that may continue to hold today as the dollar could stabilize. The risks for today appear more skewed towards a pull-back to the 1.1300 level as markets may have turned too optimistic too soon on a diplomatic solution in Ukraine.

In the eurozone, the focus will mostly be on ECB speakers today (although they have had a limited impact on the EUR lately), with De Cos and Lane scheduled to deliver remarks.

GBP: Data helping aggressive BoE pricing

1.3600 is proving to be quite tough resistance for GBP/USD, and one that may hold until the end of this week as geopolitical risks may linger and give some support to the dollar. Meanwhile, a week of data releases in the UK has continued to endorse the market’s bets on BoE tightening (here’s our economist’s take on yesterday’s CPI report).

Even though the six hikes priced in for the rest of 2022 seem too aggressive in our view, the market’s pricing may not be heavily challenged until later in 2Q (BoE set to hike in March and May), which means the pound should remain supported in the coming weeks if global risk sentiment proves benign.

AUD: A popular choice, but not for long

Yesterday, in a generally supported pro-cyclical segment, markets seemed to favor the Australian and New Zealand dollars, two currencies that can benefit from the improvement in risk sentiment without being a) as exposed to the Ukraine situation as European currencies and b) as exposed to risks of a correction in oil prices as CAD and NOK if tensions de-escalate.

Domestically, we saw rather unexciting Australian jobs report for the month of January overnight. A marginal increase in employment (13k) was only due to part-time hiring as full-time jobs fell (-17k). Still, the unemployment rate remained unchanged at 4.2%, a level that would in theory put pressure on the RBA to turn more hawkish, but not in the current situation where policymakers have put much more focus on wage growth data – which will be published next week. Incidentally, the RBA policy has been a secondary factor for AUD compared to external drivers and given the recent wide swings in sentiment due to geopolitical tensions, we doubt this will change in the near term.

AUD/USD is attempting a decisive break above 0.7200 at the moment: this could happen within the next few days, but USD strength and multiple external woes for AUD mean that a pull-back to 0.7000 seems more likely in the coming weeks.