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FX markets continue to trade with cautious optimism on the view that a US slowdown can rein in a hawkish Fed and that a reset in China policy will (eventually) see resurgent consumer demand and perhaps even improved foreign relations. That looks like a good story for the commodity and EMFX complex. Look out for comments from Fed Chair Powell today and the NFIB.
 

USD: Powell pushback?

Risk assets have started the year on a strong footing, with a good performance from both equity and debt markets. Emerging markets are back in fashion after a tough couple of years, where the building view that the Fed can soften its pressure on the monetary brakes plus China re-opening can see quite a strong recovery in emerging market currencies against the dollar. We note with interest a piece in the Financial Times today speculating on China's approach to stimulating domestic demand and also seeking to improve foreign relations. China's softening of a ban on coal imports from Australia and yesterday's news of a 20% increase in crude oil import quotas are consistent with the article.

This comes at a time when the market is growing increasingly confident that the Fed will end its tightening cycle this quarter and embark on an easing cycle in the third quarter. Today will see two inputs into that Fed story in the form of i) comments from Fed Chair Jerome Powell around 15CET today and ii) the NFIB small business sentiment survey. Powell is speaking at a Riksbank conference on central bank independence, making it unclear whether he will today push back against the recent softening in US financial conditions. Certainly, the market does not buy into the Fed's narrative of the funds' rate being taken to 5.00% and being kept there for a long time. Markets seem to price a 50bp easing cycle in 2H23.

Regarding the NFIB survey, the market will be interested in whether it sinks any further and supports the recessionary readings provided by last Friday's ISM services release.

Assuming that neither Powell's comments nor the NFIB breaks the building narrative of a more relaxed Fed (and Thursday's US CPI will also be key for this story), we would expect momentum to remain against the dollar and continue to favor activity/commodity currencies. Speculation will also be building that the Bank of Japan might have a further Japanese government bond (JGB) yield target adjustment in store after the Tokyo ex-food CPI hit 4% year-on-year – a level last seen in 1981. The Bank of Japan meets next week.

DXY looks biased towards the 102.00 as investors put money to work on non-USD assets.
 

EUR: So far, so good

EUR/USD managed to nudge up to a new high yesterday without the support of much new news. It seems that asset managers are starting the year by placing money overseas, where dollar sales for emerging market currencies seem to lift EUR/USD as well. That said, European equities continue to outperform at the start of the year and eurozone data also continues to surprise on the upside. 

For the time being, we would prefer to back further EUR/USD strength – should today's US event risks allow. This could see EUR/USD pressing last May's high at 1.0785. This week there is an outside risk of 1.0950 should Thursday's US December CPI show another soft reading. Before we dust off the call to 1.15, we should note that a re-opened China will compete for global LNG supplies. This means that the issue of high natural gas prices could well come back and bite the eurozone and the euro later in the year.
 

GBP: Better risk environment provides some insulation

Sterling has been performing slightly better, helped no doubt by the constructive risk environment at the start of 2023. The UK has quite a large country weight in global equity and debt benchmarks, meaning that flows into these products can provide some support. Sterling barely budged yesterday on comments from Bank of England Chief Economist Huw Pill that there were early signs that the UK labor market was softening. Again, market pricing of a further 100bp BoE hike to the 4.50% area this summer looks resolute.

0.8770-0.8870 may well contain EUR/GBP for the rest of this week, though GBP/USD could have some more upside should US data allow.
 

CEE: Romania closes the hiking cycle in the region

Today's calendar in the region offers a National Bank of Romania (NBR) policy meeting. Although it seemed likely that we would not see another rate hike after the last meeting, the November inflation number has convinced us that one more hike is more than likely. That is why we expect the last 25bp rate hike today to 7.00%. However, our chief economist in Bucharest, Valentin Tataru, gives a 30% chance that rates will remain unchanged today. A rate hike is unlikely to impress anyone, and we will look for clues as to how the NBR views the liquidity situation in the market. From a rate perspective, we think this meeting should be the last live one, which will close the CEE region's hiking cycle, given that we do not expect rate hikes anywhere else. 

The Romanian leu, like the entire CEE region, has benefited from favorable global conditions in recent weeks and, with the exception of the last few days of last year, has remained below NBR intervention levels. Although Romania is the least energy-dependent country in the region, the positive impact of the drop in gas prices and the more favorable EUR/USD level has not avoided the Romanian market. These conditions are expected to persist in the coming weeks. Although the carry level is among the lower ones within the region, it is at least stable. Moreover, the central bank maintains strong market confidence not to allow a depreciation above intervention levels. Thus, in our view, any EUR/RON upward moves may be tempting for RON buyers.

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