FX markets start the week on a calmer footing as investors assess the hawkish turn by many central banks and also diplomatic efforts to ease tensions surrounding Ukraine. The macro highlight of the week will be Thursday's release of US January CPI, plus hawkish turns from Poland and perhaps even the Riksbank too. We favor the dollar staying bid.
USD: Dollar downside should be limited ahead of Thursday's CPI
A surprisingly strong US January NFP jobs report provided some support to the dollar and reminded us that the Fed is still likely to lead the hawkish re-assessment of central bank policy underway around the world. To those that argue that the Fed cycle is fully priced, we would say take a look at the 1m USD OIS rate priced two years' forward. That broke to a new high on Friday and that could well be headed to the 2.50% area from levels just above 1.80% today.
In terms of which currencies may suffer the most against a stronger dollar, we are probably just left with the Japanese yen and the Swiss franc - both with very dovish central banks and a history of deflation. Indeed, the hawkish shift by the ECB last Thursday has allowed German Bund yields to break free, and in turn allowed another leg higher in US Treasury yields. These 10-year yields are now at 1.90% and could edge higher still, especially with a lot of US Treasury issuance due this week. Equally one would expect US rates markets to stay cautious ahead of what should be a new cycle high in US CPI on Thursday.
The main threat to what otherwise would be a clear call for USD/JPY to test and break the 116.35 high (we see 120 later this year) is the geopolitical risk - largely Ukraine-related. Today French President Macron is in Moscow to speak with his counterpart, while German Chancellor Scholz is in Washington meeting President Biden. Risk assets are continuing to favour a diplomatic solution here. For example, Ukraine's two-year USD bond yields now 12.5% versus a recent high of 16%. Markets do not quite know what to make of a stream of comments (largely coming from US sources) that an invasion is imminent. Clearly, any progress on the diplomatic front would be very welcome and likely take the S&P 500 back through important resistance at the 4590/4600 area - a key benchmark for the risk environment.
For today expect narrow ranges in the DXY - but support at 95.00/95.25 seems a little stronger after Friday's NFP release.
EUR: Look out for Lagarde comments at 1645CET
Over the weekend we saw some interesting comments from ECB's Klaas Knot, a known hawk. He could see a 25bp ECB rate hike in October, but favours 25bp increments; currently the focus has been on the ECB starting in 10bp increments perhaps as early as July. He also admitted that eurozone inflation is externally generated through energy prices, unlike the US where inflation is largely internally generated. This looks like a key point, a reminder that the US runs a large positive output gap (compared to the negative output gap in the eurozone) and that the US tightening cycle will likely be far larger than that seen in Europe. That is why we favour EUR/USD proving toppish near the 1.15 area, rather than calling a major upside breakout.
For today, we have just seen a soft German December Industrial Production figure, but the main focus will be comments given by President Lagarde at 1645CET today. Should she feel the need to correct any of the sharp adjustments seen in European interest rate markets (and correct the pressure on BTP-Bund spreads), today's introductory comments could present such an opportunity.
We have a slight preference for EUR/USD drifting back to the 1.1380 area today.
Elsewhere this week we should see an interesting Riksbank meeting on Thursday accompanied by a new round of forecasts. This could be the catalyst for EUR/SEK to retest 10.36.
GBP: Staying supported
GBP is staying reasonably supported after last week having been hit by the hawkish re-assessment of ECB policy. We do, however, think that GBP can fight back in 1H22 as the front-loaded BoE tightening cycle gathers momentum. We would not be surprised if EUR/GBP this week drifted back to the 0.8400 area near term.
PLN: Gearing up for a hawkish NBP tomorrow
Our team in Warsaw on Friday published a note highlighting the hawkish turn from the NBP. We now expect a 50bp hike from the NBP tomorrow - taking the policy rate to 2.75% - with the risk of a 75bp hike. Additionally, it seems that the Polish government is also softening its stance against Brussels and making more conciliatory noises, no doubt to strengthen Western alliances over Ukraine but perhaps also with one eye on the release of EU recovery funds.
Our team sees EUR/PLN ending the quarter at 4.48. And despite signals that the Czech National Bank is close to finishing its tightening cycle, expect foreign investor interest (including central bank reserve manager interest) in Czech government bonds to keep the CZK supported too.
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