Head of FX Strategy
Summary: The US dollar got a boost overnight and today after comments from Fed Board of Governors member Waller, who argues for several more 50 basis point Fed rate hikes, rather than just the two (followed by smaller hikes thereafter) that that the market was getting increasingly comfortable with projecting. As well, US President Biden has invited Fed Chair Powell to the White House for a meeting today. Is this for a dressing down on the Powell Fed’s failure to move more aggressively against inflation?
FX Trading focus: Watching for new shifts in Fed tone as Powell headed to White House meeting today
We have the US dollar pushing back a bit higher today on two developments: the Fed’s Waller arguing for “several” 50 basis-point rate hikes, which has helped boost US treasury yields all along the curve, and as the risk bounce fades on that development, as well as on the impact of a significant further rally in energy prices. The latter was a product of the EU agreeing to a new package of sanctions that will see the elimination of all sea-borne imports from Russia over the next six months, which is about two-thirds of the usual import volumes. Pipeline flows could continue, keeping especially Hungary happy for now.
Besides the Fed’s Waller helping bring back about nine basis points of tightening onto the 2022 calendar year, we also have the headline that US President Biden has invited Fed Chair Powell to the Oval Office, a rare event that between the lines suggests Biden will do everything he can to strong arm the Fed Chair into a more forceful policy stance. Let’s recall the inflation focus in the Fed Chair’s renomination speech, together with similar comments from then Vice Chair nominee Brainard. Can’t help but note the timing here as the invite coincides with the beginning of the US driving season and possible summer of discontent just after US gasoline prices have surged to a nominal record (still solidly below the prior peak on an inflation adjusted basis). Is the Fed set to double down? The answer to this question together with the reception of the US data through this Friday’s jobs report and the beginning of QT tomorrow and whether we are set for fresh pressure to the upside in longer US treasury yields and therefore the US dollar.
Chart: GBPUSD
If the US dollar is set to take a stand here on a fresh rise in yields after Biden refreshes Fed Chair Powell’s memory today on the necessary Fed policy pivot that was the condition for his renomination (fight inflation and don’t worry about anything else), then the sterling looks like a good place to choose shorts versus the US dollar. Nothing has suddenly improved in the UK outlook over the last couple of weeks, we have merely seen a significant bounce after an epic rout from above 1.3000 to below 1.2200. A return of the price action below 1.2500 would suggest a local reversal here and a possible setup for a run to the important chart level at 1.2000.
Sweden’s economy supposedly hit a speed bump in Q1, with the estimate yesterday coming in at -0.8% QoQ vs. -0.4% expected, much of it on the drag from trade as high import energy prices weighed and exports looked relatively sluggish on upward revisions of prior numbers. But credit growth suggests domestic demand is humming along nicely, despite the most recent consumer confidence reading registering the lowest level in decades as is the case in many countries. A Bloomberg article today highlights Sweden’s commercial property sector activity in freefall after a record year in 2021 and before the Riksbank has even managed to hike rates in earnest (although the bank did achieve lift-off in April and the forward curve has seen a massive adjustment higher on the Riksbank’s dramatic reassessment of the likely policy path). Traditionally, Sweden’s economy is very pro-cyclical as it is leveraged to external demand for its products. But all of the small open economies like Sweden (and including Denmark, Australia, Canada, etc.) have seen the most aggravated of property bubbles on the many years of zero/near zero and even negative rates since the global financial crisis. On the residential side, Statistics Sweden’s average housing price indicator has risen from about 3 million just prior to the pandemic to 4 million now and up from about 2 million just after the global financial crisis. Higher yields are a massive headwind for all of these economies through the asset valuation mark-down risks. Major studies by the US Federal Reserve among others have shown that property bubbles cause enormous long-term hangovers once they pop, and Sweden’s never came close to doing so. Back in 2010-11, the Riksbank thought it could normalize and tried to do so by hiking rates to 2.0% from 0.25%, but triggered an immediate recession that saw it backtracking and cutting the policy rate to -0.5% by early 2016. Back then, the global backdrop allowed such a move, as inflation was a non-issue, particularly after the collapse in oil prices in 2015. This time around, not so much.
An interesting story out overnight flagged to me by my esteemed colleague Redmond Wong was the upward revision to 2.0% from 1.2% YoY in Japan’s March wage data, a potential game changer if similar levels or higher of wage growth are posted in coming months. The wage data series is somewhat erratic, so we can’t jump to conclusions, but it is the kind of data that would allow the BoJ to soften up its commitment to the existing yield-curve control policy. In general, the political pressure on the BoJ can only continue to mount from her if oil prices continue higher and raise the cost of living in Japan, aggravated by the weak JPY which is almost 25% weaker in REER terms from two years ago. The JPY was a touch firmer overnight after dropping in the wake of the surge in US yields. Prime Minister Kishida is set to tout a “New Capitalism” policy push that seeks to shore up inequality risks. More to come on that effort.
Table: FX Board of G10 and CNH trend evolution and strength.
Too early for this USD bounce to show up on our trend indicator, but the USD trend status looks pivotal through Friday. The commodity currencies have been trying to get something going and AUDUSD is close to last gasp resistance areas and USDCAD has been interacting with the important 200-day moving average area.
Table: FX Board Trend Scoreboard for individual pairs.
Note the robust extension of the bounce-back in AUDNZD as a likely end to the NZD comeback attempt within than exchange rate. That pair may be ready to challenge near 10-year highs on a break of the 1.1100+ top. Elsewhere, the Euro is suffering against commodity FX on the new Russia sanctions, EURCHF 1.0225-50 area bears watching. Finally, the GBPUSD trend reading will be easy to flip back to negative on a heavy couple of days of trading – and GBPJPY is even closer to flipping negative if the JPY perks up again.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
