Head of FX Strategy
Summary: EU sovereign bonds caught a strong bid today, the last day of the quarter, after a brutal run lower year-to-date, in part on ECB Chief Economist Lane out arguing that ECB policy can still go in either direction. This checked the euro advance from earlier this week, which was already built on the rather shaky foundation of hopes that the war in Ukraine is moving toward détente. Further bad headline on that front also pressure euro pairs today.
FX Trading focus: ECB’s Lane caps euro advance. JPY and last day of Japan financial year. Next tests for Fed credibility.
The EURUSD advance was checked today in part by surprisingly dovish rhetoric from ECB Chief Economist Lane, who fretted the impact of soaring energy prices on growth prospects and argued that policy still needs to consider two-way risks from the ECB’s latest favourite word: “fragmentation”, which is the code word for uneven monetary policy transmission across the Euro zone due to perceived variation in credit strength by the various EU sovereigns that drove peripheral spreads wider together with the general sharp rise in EU yields in February, if failing to do so since the Russian invasion of Ukraine. After the latter, the strong sense of solidarity and large mutual EU debt issuance has made a strong impression and there has been no fragmentation since then even as yields have risen sharply again in recent weeks. Nonetheless, I have long considered it more likely and appropriate that the ECB ends up hiking rates for inflation credibility while still maintaining selective QE to avoid peripheral spreads blowing as they might if their QE ends. It is either that or a deepening commitment to a mutual fiscal foundation after the first steps in this direction were made in response to the pandemic, and now more impressively in the wake of the Russian invasion of Ukraine.
As discussed in the EURUSD chart below, this dovish blast from Lane and others at the ECB has turned the EURUSD rise in a very pivotal technical area, underlining its importance. The euro was under pressure broadly on today’s developments, as the war impacts clearly need to lift durable for the euro to realize its potential. EURGBP is at an interesting inflection points as well, having closed above its 200-day moving average (0.8470) yesterday and trying to follow through higher before a vicious reversal set in.
Chart: EURUSD
A mini-swarm of developments have seen the euro in steep retreat today after the sharp rally Tuesday that was built on the rather shaky foundation of hopes that Russia’s announcement of a cessation of operations in the Kyiv and other areas were a step in the direction toward détente. This hope has yet to pan out with any further developments, as natural gas prices remain elevated in EU and the latest leg lower in the euro around lunch-time in Europe today seemed triggered by Italy’s Prime Minister Draghi saying that Putin told him that conditions are not right for a cease-fire and that it is too early for a meeting with Ukrainian president Zelenskiy. Besides Chief Economist Lane’s dovish comments today, we also had the ECB’s Guindos out saying that he hasn’t seen many signs of rising wages yet and that he hopes inflation will peak in the next two to three months as part of the inflation shock is linked to temporary factors. The EURUSD action turned tail today after having bulled almost precisely to the late 2021 low at 1.1186. A weak close today underlines the importance of the 1.1125-1.1185 resistance zone and keeps the focus on the lower zone for now.
JPY: finally, end of financial year in sight. The dovish ECB musings are taking some of the sting out of the yen’s recent dire isolation, as EURJPY corrects further. But the solid rally in US treasuries since the beginning of the week is the more important JPY-supportive coincident indicator at the moment and the one to watch going forward as we have important US data on tap today (more below) and a new quarter getting underway tomorrow after a brutal one for most of Q1 for fixed income assets, which has likely helped trigger some portfolio rebalancing in support of bonds this week.
Test of Fed credibility into next week. Today sees the release of the Feb US PCE inflation data, which is weeks after the BLS CPI data series, but nonetheless could carry some weight with the Fed as it is the Fed’s preferred inflation indicator. A higher than expected PCE number together with a strong jobs (and especially earnings) report tomorrow would be the latest test for this Fed and its attempt to catch up with the curve. Yesterday’s March ADP private payrolls number was out at a more than solid +455k, though we have seen some wild revisions in that and the official data in recent months. By the way, a good discussion on financial conditions on today’s Saxo Market Call podcast as we look at some indicators suggesting tightening financial conditions (likely those linked to rising nominal yields, especially for mortgage rates) while market measures of financial conditions (volatility and credit spreads, for example) have improved at a blistering pace over the last couple of weeks. Is the Fed focusing on the whole picture?
Table: FX Board of G10 and CNH trend evolution and strength.
Some solid mean reversion in the JPY sell-off this week – but as noted, an important calendar roll taking place today. Elsewhere, note the interesting AUD drop, and oil-linked currencies struggling on US President Biden’s plan for a sustained release of strategic reserves.
Table: FX Board Trend Scoreboard for individual pairs.
The AUDNZD up-trend looks derailed on the charts after the recent sharp reversal, though this reversal not showing up yet in the trend reading. Elsewhere, note NOKSEK suffering on this latest crude oil sell-off. USDCNH is a waste of time as it has merely mean reverted back to the middle of the range it has traded all year. China is signaling more policy support overnight after weak official PMI’s, particularly for Services (48.4).
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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.
