FX Update: USD outguns EUR despite ECB hawkish surprise. FX Update: USD outguns EUR despite ECB hawkish surprise. FX Update: USD outguns EUR despite ECB hawkish surprise.

FX Update: USD outguns EUR despite ECB hawkish surprise.

John Hardy

Head of FX Strategy

Summary:  The ECB shocked rates markets in Europe with the scale of its hawkish guidance yesterday, with short rates leaping to new cycle highs. The Euro knee-jerked sharply stronger as well, even as its strength versus the USD faded as the latter enjoyed a strong safe-haven bid on cratering risk sentiment. Sterling headed sharply lower, meanwhile, amidst dovish dissent on the bank’s 50-basis point hike yesterday and lower guidance on further rate rises.

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FX Trading focus: USD rebounds sharply on sentiment swoon. EUR firm, after over-ambitious ECB hawkishness, if not against the USD. Sterling gets a deserved slap after the Bank of England meeting

The ECB administered a hawkish broadside yesterday, raising its forecasts for headline inflation to 6.3% for next year and 3.4% for 2024 (From 5.5% and 2.4% previously, suggesting a far longer time frame with uncomfortably high inflation. The core CPI forecasts were raised to 4.2% ex food and energy for 2023 and 2.8% for 2024, versus 3.4%/2.3% in September). It also outlined its quantitative tightening plan to start rolling off EUR 15 billion of asset per month from March, with ECB President Lagarde claiming the willingness to continue to hike 50 basis points at several coming meetings if necessary, with a general message that there is far more rate tightening to do from here. But after an initial sprint higher that saw EURUSD trading well above 1.0700 despite relative USD firmness elsewhere, the EURUSD collapsed back toward 1.0600 before stabilizing closer to 1.0650 this morning and then easing lower again. Still, the euro was very firm against most of the rest of G10 currencies as the German 2-year yield jumped a full 25 basis points on the day and closed the day at a cycle high (and high since 2008) of 2.39%.  EURJPY leaped two figures higher and EURGBP ripped higher on a dovish Bank of England. More on the ECB in the EURUSD chart discussion below.

The Bank of England delivered the expected 50 basis point hike, taking the rate to 3.5%. The decision was not unanimous, as two dovish dissenters favored no rate hike and one preferred a 75-bp hike. Markets are pricing in a peak for the BOE above 4.50% by mid-year next year, but the Bank’s guidance suggests this still looks ambitious. Its downbeat assessment on the economy has it projecting an extended recession and inflation all the way back to below target within two years. UK yields fell around 10 basis points yesterday on the BoE, but the rip higher in EU yields after the ECB yesterday has erased that development and then some this morning, with a resilient preliminary UK Services PMI (50.0!) offering a bit of support. Still, EURGBP jumped all the way above 0.8700. The Bank of England does have the luxury of a more cautious approach as the Sunak-Hunt fiscal austerity will pull a lot of weight in fighting inflation for the coming quarters. One of the reasons the ECB may have felt motivated to present a more hawkish face, on the other hand, is the concern that fiscal expansion will continue in the EU and aggravate inflationary risks next year.

Elsewhere, the SNB was a non-event that delivered the expected +50 basis points, with EURCHF very rangebound. The Norges Bank surprised slightly hawkish by saying that it will “very likely” hike again in Q1, but with rather modest impact on short Norwegian rates. The risk off since yesterday and ECB hawkishness has the EURNOK rate back toward 10.50. That area has been very strong resistance this year.

EURUSD posted a powerful intraday reversal after the surprisingly hawkish ECB meeting yesterday first took the pair to new cycle highs north of 1.0700. The action shows that when risk sentiment is beating a retreat, the USD nearly always emerges on top. Two observations on the ECB’s sharp revision higher in inflation forecasts and loud. One is that inflation risks may be greater from here for the EU as long as the continent continues to pay through the nose for its energy and as long as fiscal retrenchment remains off the table (as noted above on relative BoE and ECB stances). But the idea that the ECB can outpace the Fed with rate hikes if the global inflationary backdrop generally fails to ease as hoped seems farfetched. As well, follow through on ECB threats of multiple additional 50 basis points hikes would quickly see not only EU growth tanking, but the EU running into problems with peripheral spread widening, the impact of rate rises on a more sluggish economy, crowding out from the needed bond issuance etc… The relative strength in the euro in the crosses is looking stretched. Here in EURUSD, the local reversal is very modest and needs to follow through to suggest a more profound reversal, starting perhaps with a retreat back to 1.0500. A failure to do so will suggest that further upside potential stays in place in the near term. We are fast running into year end (consider USD liquidity issues discussed below), with some perhaps not willing to make significant directional bets until the New Year.

Source: Saxo Group

Looking forward to next week, the last US data points of the year include the Consumer Confidence survey up on Wednesday and the Friday PCE inflation data (less anticipation around that after the mixed reaction to the soft CPI data this week). Possibly acting against the US dollar’s upside potential is the ongoing generous USD liquidity provided by the Treasury drawing down its general account just as it did last year. This same issue will become a headwind for liquidity and support for the greenback some time next quarter as the Treasury will eventually build reserves again once the singularly stupid budget ceiling hurdle is cleared.

Table: FX Board of G10 and CNH trend evolution and strength.
The USD comeback is by no means a trend just yet – so far just a strong reversal. Next session or two important on that front for whether anything more will materialize for USD bulls until at least after the calendar roll. GBP strength has now been neutralized as we await next steps.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
Watching USD pairs over coming days to see if there is a follow-on move after yesterday’s rally attempt. Some G10 trends long in the tooth, especially the USD and CAD pair downtrends and the NZD pair up-trends. Note EURCAD and think of the relative long-term energy security of the two economies for a bit…hmm.

Source: Bloomberg and Saxo Group

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