G10 FX Week Ahead: Crosswind Landing

Like the storm-hit UK, global markets are facing strong winds as the geopolitcial situation in Ukraine remains volatile. Sticking to our metaphor, we may not see any smooth "landing" in diplomatic talks next week, and markets may start settling in with the prospect of prolonged geopolitical risks, helping the US dollar, Japanese yen, and, Swiss franc. Expect another hike by the RBNZ.

Boeing 737 in crosswind landing

USD: Ukraine Turning Into a Longer Diplomatic Game?

Geopolitical developments in Russia and Ukraine have driven nearly all moves in the FX market this week and are inevitably set to remain in center stage in the week ahead.

Indeed, the past few days showed that a quick and relatively seamless diplomatic resolution is unlikely: Ukrainian forces and pro-Russian militants are accusing each other of violating a cease-fire, while NATO sources have shed doubts on whether Moscow has indeed withdrawn some of its troops.

The Blinken-Lavrov meeting next week is seen as the next pivotal event, but an extension of the diplomatic stalemate could make markets somewhat less sensitive to Ukraine-related headlines, and likely more comfortable with continuing to factor in some (moderate) degree of geopolitical risk into asset classes.

We think this means that the downside should remain quite limited for the dollar and the other safe-havens in the week ahead. On the domestic side, the US data calendar is set to be very quiet, with some focus only on the second read of Q4 growth figures.

Markets have marginally scaled back expectations around a 50 bps hike by the Fed, but next week’s Fedspeak agenda includes a few hawkish voices (Bostic, Mester, and Waller), which could revamp speculation on rate-hike front-loading and further help put a floor under the dollar.

EUR: Not Much Geopolitical Risk Priced In

The EUR/USD pair is a story of contrasting factors, which have kept EUR/USD within the 1.13-1.14 range over the past few days. On one side, geopolitical risks are preventing a move to 1.1400, on the other, the market’s reluctance to fully price out summer tightening by the ECB is still encouraging some buying in the dips.

That said, we estimate the short-term fair value for EUR/USD to rest around 1.1200, which means that a) the geopolitical risk premium is likely contained; and b) there is room to catch up with a less supportive rate differential.

We expect EUR/USD to inch lower in the week ahead as investors may remain cautious on a diplomatic solution in Ukraine and a recovery in the Eurozone’s PMIs and in the German Ifo are widely expected as the Omicron impact faded in January.

Markets will keep an eye on ECB speakers (De Cos, Guindos, Schnabel), but we wouldn’t be surprised if the current rate expectations remain broadly unchanged until the March 10 meeting.

JPY: Keeping an Eye on The 115.00 Level

In the current volatile geopolitical environment, it appears unwise to bet against the yen (which can also benefit from a quite stretched short positioning), especially in the crosses against high-beta currencies. That’s despite a longer-term outlook for the yen that remains clouded by the prospect of steadily rising UST yields.

It looks like the 115.00 level in the USD/JPY pair is a key benchmark level for the market’s sentiment related to the Ukraine situation, and support around that level has indicated some reluctance to price in any tail risk. We think, however, downside risks may persist in the pair, and even more in the EUR/JPY pair, which may find more bearish tailwind if we see a break below 130.00 next week.

GBP: Data to Remain Benign

The pound has been able to count on some rather supportive data-flow this past week, as wage growth, inflation, and retail sales all accelerated in January. This has allowed markets to cement expectations for two more BoE hikes in March and May and at least five by the end of the year.

Next week, we expect a bounce in PMIs to endorse the good growth momentum for the UK's economy. Markets will also keep a close eye on a number of BoE speakers, including Governor Bailey (who testifies to the Parliament’s Treasury committee) and Chief Economist Pill.

Domestic factors are offering some shield to the pound, which is pricing in very little geopolitical risk. While we expect the pound to face less downside risks compared to the euro in the week ahead, US dollar strength could push it back to test 1.3500.

AUD: Wage Growth, Ukraine, and Iron Ore in Focus

The Australian jobs market showed some resilience in January, with the unemployment rate holding at 4.2%. Still, the Reserve Bank of Australia has explicitly said it will wait for evidence of wage growth acceleration before turning decisively more hawkish, and next week’s wage data will be watched closely.

Looking at consensus expectations, however, the wage price index may have accelerated only mildly in Q4 (from 2.2% to 2.4% year-over-year). Indeed, the Q1 release (on May 18) will be the key one, but for now a modest increase in wages should help the RBA stick to its patient stance.

That said, the impact on the Aussie should be quite contained and likely out-shadowed by global geopolitical sentiment. The AUD/USD pair has been showing some negative risk premium worth around 1.5% according to our short-term fair value model, but we think downside risks may persist. The woes in the iron ore market due to China’s crackdown on price speculation could also keep the upside capped for the Australian dollar.

NZD: RBNZ To Hike and Signal Fast Tightening

Despite the recovery in the past few days, the NZD/USD pair is around 1% undervalued due to geopolitical risk, which may not be priced out just yet by the end of next week.

However, domestic development will also be in focus in New Zealand as the RBNZ announces monetary policy and is widely expected to hike rates by another 25 bps, bringing the Official Cash Rate to 1.00%.

The focus will be on the forward-looking language, and we think the RBNZ will signal a rather fast pace of tightening, justified by a tight jobs market, high inflation, and (implicitly) still elevated house prices (which grew 27% year-over-year in January).

We think this should keep markets comfortable with their current hawkish pricing for RBNZ tightening (at least six hikes by year-end) and give some help to the New Zealand dollar, which should face smaller downside risks compared to the Australian dollar next week.

CAD: No Domestic Drivers

The loonie has been somewhat protected from geopolitical tensions due to the positive spill-over on crude prices. Still, the USD/CAD pair is around 1.5% overvalued, meaning that there is some room for recovery once geopolitical tensions dissipate (may not be a story for the short-term) even if oil prices retract.

Canada's data calendar is very quiet in the week ahead after the past few days saw a jump in inflation to 5.1% and a smaller-than-expected slump in retail sales in the December read. Expect the USD/CAD pair to track global sentiment very closely next week, with the possibility to test 1.2800.

CHF: EUR/CHF Pair can Move Below 1.04

The EUR/CHF pair may continue to stay pressured in the week ahead, given its high exposure to the Ukrainian crisis. Incidentally, a Swiss National Bank that seems more relaxed towards a stronger franc and widening EZ peripheral spreads all point to more weakness in the pair. A break below 1.0400 looks likely in the coming days.

NOK: Volatility Set to Persist

Scandies have been the quintessential benchmark for Ukraine geopolitical tensions, and despite the support offered by rising oil prices, the krone was likely penalized by being overbought before tensions flared up, which left it exposed to a sizable long-squeezing. Also, the krone is the least liquid G10 currency which makes particularly vulnerable in a risk-off environment.

The EUR/NOK pair is currently 1.7% overvalued according to our short-term fair value model, but we definitely do not exclude the possibility that the pair will break the mid-December highs. Domestically, Norges Bank exiting Governor Olsen will deliver a speech Tuesday while unemployment data should have no FX impact.

SEK: The Best Gauge of Geopolitical Risk

The Norwegian krone has likely shown a bigger drop compared to what global markets are pricing in, in terms of geopolitical risk. The Swedish krona appears as the best gauge of geopolitical sentiment at the moment, as it combines high geographical and risk-sentiment exposure with a lack of other influences such as domestic tightening bets or sensitivity to certain commodity prices.

On Friday, we saw a jump in core CPIF inflation to 2.5%, but Prospera’s surveys continued to show quite anchored CPIF inflation expectations (at 2.4% in one year) and implied no tightening by the Riksbank this year. Next week’s data highlight will be the Economic Tendency Survey, but geopolitical tensions will likely drive nearly all krona moves.

We think the USD/SEK pair can break above the late-January highs and test 9.50, while the EUR/SEK pair may face a somewhat more contained upside. Still, 10.70 appears clearly within reach.