FX Update: How will FX react to the realization that stagflation has arrived?
Head of FX Strategy
Summary: It is easy for commodity currencies to advance strongly when only the inflationary component of stagflation is in play, but what happens across FX if risk sentiment starts to consider the outlook for sharply weaker growth, especially if yields rise further? Key tests lie ahead on that account for the most yield-sensitive currency the Japanese yen, as well as classically pro-cyclical commodity currencies.
FX Trading focus: Stagflation is here: once realized, how does that impact recent developments?
There was no add-on CNH strength after yesterday’s remarkable rally in the currency that nearly took it a full percent stronger versus the US dollar in the strongest sell-off in the USDCNH pair in a single day in nearly a year. In this morning’s Saxo Market Call podcast, our Steen Jakobsen linked this move with rising commodity prices in China as well as policymakers there moving in a successful rhetorical intervention against the latest spike in domestic coal prices. The podcast outlines the stagflationary risks facing the economy, underlined this morning by incredible Germany PPI prints showing a record +.23% month-on-month increase and +14.2% year-on-year.
Steen believes that it is only a matter of time until yields lift further and all along the curve as sustained inflation levels will handcuff central banks on providing further liquidity support. If so, rising long yields would prove a very interesting test for both the Japanese yen and risk sentiment generally as the highest-flying portions of the equity market are extremely interest rate sensitive. Yesterday, the US 10-year treasury yield benchmark closed at a new local high and followed through a bit higher still overnight, taking USDJPY to a new high since early 2017 above the key 114.50 area. But both USDJPY and US treasury yields eased back lower in early European trading. The 114.50-115.00 area is monumentally important for that pair. The US Treasury will auction 20-year treasury notes later today.
If the risk of a sustained stagflation is recognized by this market, we’ll also have an interesting test of other prominent currency market developments of late, namely the strong outperformance of commodity-linked currencies. That outperformance is a no-brainer when risk sentiment is on full tilt to the upside as we have seen over the last week, but how can the latter be sustained if the market starts to price in a higher cost of capital as well as weaker growth and weaker earnings growth risks? As discussed in the look at the AUDUSD chart below, that pair will be interesting to watch if the backdrop shifts gears in coming days/weeks.
As noted above, interesting to see how any realization of stagflationary risks affects key currencies that sit astride conflicting themes that such a realization brings. The risk of ever higher commodities prices and an eventual repricing of the forward rate curve as the RBA trips over its forward guidance by early next year could prove very supportive for the Australian dollar, while the risk of cratering risk sentiment and forward concerns for the real growth outlook could add a negative drag. For now, AUDUSD is knocking at the door on key resistance and has poked above the local pivot high. I would like a couple of ugly days of equity markets selling off with AUDUSD simply taking that development in stride and not selling off before believing that we are headed for a major push higher back into the zone above 0.7600. But regardless, the technical lay of the land is such that the 0.7500-0-7600 zone looks to be the key for establishing whether the chart remains structurally bearish or is neutralized by a rally back into the upper zone.
Hungary added another odd 15 bp hike yesterday, taking the rate to 1.80%. After surprising markets at the previous meeting with a mere 15 basis point rate hike (versus 30 bps expected) that saw the Hungarian forint weakening sharply, the Hungarian central bank met expectations and once again hiked by this small increment with the same result – a weaker HUF weaker, as EURHUF traded above resistance since earlier this year around 362. The central bank chief Virag said in the wake of the decision that “the fight against inflation is similar to long-distance running, not to a sprint”, but it looks like the central bank will need to hike more and more quickly to slow the HUF’s descent. The all-time highs in EURHUF are just ahead of 370, posted just after the pandemic outbreak last year. In the background, the escalating confrontation between Poland and the EU over rule-of-law issues and the disbursement of EU Recovery Plan funds looks critical. Could the EU be soft-pedaling its confrontation with Hungary for now until it gets a look at the election results in the spring as the united opposition in Hungary to Orban’s government is polling well and could end his reign. The new leader of that opposition has voiced hopes for stronger ties with the EU.
Table: FX Board of G10 and CNH trend evolution and strength
The JPY reading has reached the remarkable -10 level, a rarified reading, as the US dollar teeters here and likely needing a punch in the gut to risk sentiment to stay resilient. Elsewhere, note the staggering momentum change over the last week in the NZD as the market prices in the RBNZ on the warpath on rate hikes.
Table: FX Board Trend Scoreboard for individual pairs
Note the AUDCAD rally sufficiently impressive to flip the trend to positive, while EURUSD isn’t far away from doing the same, but chart-wise needing to vault above 1.1700.
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