G10 Currencies

FX Daily: Late cycle dollar strength meets the carry trade We see two key themes driving FX markets near term. The first is central banks continuing to battle inflation, yield curves staying inverted, and the dollar continuing to hold gains. The second is cross-market volatility continuing to sink - generating greater interest in the carry trade. Expect these trends to hold into Fed, ECB and BoJ meetings next week.   USD: Late cycle dollar strength continues Yesterday's surprise rate hike by the Bank of Canada (BoC) triggered quite a clean reaction in FX markets. Of course, the Canadian dollar rallied on the view that the BoC had unfinished business when it came to tightening. But the broader reaction was for short-dated yields to rise around the world, for yield curves to invert further, and for the dollar to strengthen. USD/JPY rose about 0.8% after the BoC hiked. The view here was that if both Australia and Canada felt the need for further hikes, in all probability the Fed would too.   This endurance of this late cycle dollar strength is therefore the key story for this summer. For the near term, it looks like the dollar can hold the majority of its recent gains into next Wednesday's FOMC meeting - though the release of the US May CPI next Tuesday will be a big market driver too. Our bigger picture call remains that the dollar will embark on a cyclical bear trend in 2H23 - probably starting in 3Q - though the risk is that this gets delayed.   This brings us to our second key observation which is that declining levels of cross-market volatility continue to favour the FX carry trade. Somewhat amazingly the VIX index - implied volatility for the S&P 500 equity index - has fallen below not just the 22 February pre-invasion levels but also below the March 2020 pre-pandemic levels.   As is the case with low rates and FX volatility, presumably investors believe that policy rates will not be moving too much this year - perhaps a little higher and then a little lower. Lower volatility levels are favouring the carry trade which in the EM world favours the Mexican peso and the Hungarian forint and in the G10 space - as Francesco Pesole points out - favours the Canadian dollar. An investor selling USD/MXN six months forward at the start of the year would have made close to 16% by now.   Expect these core trends to continue for the near term. The data calendar is light today and we suspect a slight pick-up in initial claims will not be enough to move the needle on the dollar. Expect DXY to linger around 104.

FX Daily: Data sensitivity at its highest A jump in US jobless claims sent the dollar lower across the board yesterday, confirming how FX markets have an extremely elevated sensitivity to data in this moment. Quiet calendars in the US and eurozone mean we could see EUR/USD stabilise, but watch Canada’s jobs numbers. Elsewhere, higher inflation has endorsed our call for more Norges Bank tightening.   USD: Jobless claim jump hit the dollar Currency markets continue to show very elevated sensitivity to data: yesterday, the increase in US weekly jobless claims to 261k against a median estimate of 235k sent the dollar weaker across the board. Lay off numbers have been rising consistently over the past few months and we could now start to see those finally trickle through to the initial jobless claims data. We must remember that there is always a period of time between lay off announcements and the actual job being cut and often no claim can be made until all severance payments have been finalised.   The Fed funds futures curve shows that markets have only marginally scaled back rate expectations after the Bank of Canada's surprise hike triggered a fresh round of hawkish bets. There are currently 7bp priced in for June, and 19bp for July, around 3bp lower (for both meetings) compared to Wednesday.   Yet, if we exclude CAD – which is trading in tandem with USD at the moment – the dollar fell around 0.7%-1.0% against all G10 currencies yesterday. It is a testament to that big FX sensitivity to data and rate expectations, and one of the reasons behind our bearish USD view for the second half of the year, when we expect both data and rates to turn negative for the greenback.   The lack of data releases in the US may offer some stabilisation to the dollar around current levels today (hovering around the 103.50 handle in DXY). Elsewhere, it’s worth keeping a close eye on Canadian jobs numbers, now that a July back-to-back hike is a tangible possibility. Consensus is looking at a solid 21k headline read, but with unemployment ticking higher from 5.0% to 5.1% and wage growth cooling off marginally, in line with what we saw in the US May jobs figures.    

FX Daily: June tells us the dollar is not the only game in town Despite relatively low levels of volatility, June has so far seen some pretty large spot FX moves in both the G10 and emerging market space. These moves seem to reflect a growing conviction of a soft landing in the global economy and a more hawkish view across the G10 central banks outside of the US. Look out for inflation surveys and central bank speakers today.   USD: Two factors weighing on the dollar We have recently been talking about inverted yield curves and late-cycle dollar strength. Looking at USD/JPY, that seems a fair comment given that it is trading not far from its recent highs and the US 2-10 yield curve is inverting even further (now -94bp) on the back of a hawkish Federal Reserve. However, this month in the G10 space, the dollar is only stronger against the yen and is anywhere from 2% (Swiss franc) to 6% (Australian dollar) weaker against the rest of the G10 currencies. This looks like a function of two factors: The first is the increasing hawkishness shown by the rest of the central banks in the G10 space. Inflation forecasts and expected tightening cycles are being revised higher across the board and in some cases more aggressively than in the US. This includes recent surprise hikes from Australia and Canada, a very hawkish ECB meeting yesterday, and very aggressive expectations for Bank of England rate hikes. The second is the bullish global risk environment. Investors are cutting allocations to cash and look to be putting money to work in bonds, equities and emerging markets. Against all the odds the MSCI world equity index is up 14% year-to-date and fund managers are surprisingly suffering from a Fear Of Missing Out (FOMO) on a good rally in benchmark risk assets. Notably, USD/CNH reversed lower yesterday despite the People's Bank of China rate cut – suggesting that investors are instead more interested in the prospect of upcoming Chinese fiscal stimulus.   Of course, data remain crucially important and will determine whether central banks need to keep rates tighter for longer or can perhaps start to consider rate cuts – as is the case in some parts of Eastern Europe and potentially Latin America too. But that is ING's central call for the second half of the year – that US disinflation will become more evident through the remainder of this year and that a less hawkish Fed will allow the dollar to sell off. Back to the short term, the dollar may well stay soft against most currencies except the Japanese yen, with the Bank of Japan remaining resolutely dovish. Here, yen-funded carry trades will remain popular. For today's data, we have the University of Michigan inflation expectations. This occasionally moves markets and any meaningful drop could nudge the dollar lower. Equally, we have three Fed speakers, generally from the hawkish end of the spectrum.  We think the mood to put money to work probably dominates and barring any big upside surprise in US inflation expectations, DXY can probably edge down to the 102.00 area, if not below.

FX Daily: Quiet start to an intense week The Independence Day holiday in the US means the week should start quietly in markets, but US data will soon attract the market's attention again now that a July Fed rate hike is a consensus view and there is also speculation about a move in September. We think the dollar can find some support this week. In the CEE region, central banks in Romania and Poland meet.   USD: Data in focus amid thin holiday volumes The month of June saw the dollar weaken against all G10 currencies except for the Japanese yen, but the greenback has been quite supported in the past few days. Some hawkish comments by Federal Reserve Chair Jay Powell at the Sintra central bank symposium last week have helped markets to close the gap with the FOMC’s dot plot projections: the Fed funds futures curve currently prices in 34bp of tightening to the peak, a 10bp increase compared to a week ago. Crucially, markets are now actively considering the option of two rate hikes. This week should start quite quietly with the Independence Day holiday meaning US markets should have reduced flows until tomorrow. Still, US data activity will peak as markets assess the probability of a September hike now that a July increase appears to be the consensus view. Today, all eyes will be on the ISM manufacturing index, although a greater focus will be on the services survey released on Thursday (the May print dropped more than expected). On Friday, jobs figures for the month of June will be published: after the latest comments by Powell, it will probably take a very weak reading to put a July hike under discussion. On the Fed side, the first event to note is on Wednesday, when the June FOMC minutes are released. The dollar can probably find some more support this week as markets see more reasons in the data and the minutes to gradually align with the more hawkish dot plot projections.

Domestic tightening stories remain key across the G10 Since the dollar is overvalued against all G10 currencies except for CHF, according to our BEER model, the same reasoning can be applied to the more general spectrum of USD crosses. Incidentally, we could see domestic stories – especially on the central bank side – dominate before a clearer dollar trend emerges later in the year. In the UK, the Bank of England’s aggressive fight against ultra-sticky inflation should keep the GBP curve highly inverted, which can ultimately keep a reserve currency like the pound supported for longer. Japanese authorities look once again on the brink of FX interventions, as USD/JPY trades close to the 145.00 mark, but some help for the yen might actually come from a hawkish tweak to the yield-curve-control policy by the Bank of Japan this summer. In Europe, Scandinavian central banks are deploying FX-supportive tightening packages. We favour NOK over SEK thanks to a more hawkish Norges Bank stance and elevated domestic risks in Sweden.    

The ADP report on employment in the private sector, published a day before the non-farm payroll data release, was so shocking that it instantly raised expectations for the labor market as a whole, leading to rapid repositioning on Friday before the data release. However, the non-farm payroll figures were significantly weaker than expected, with 209,000 new jobs created (225,000 expected), and data for the previous two months were revised downwards by 110,000. Employment growth is slowing, but the pace remains high. As for wage growth, the figures were an unpleasant surprise for the Federal Reserve. In June, wages increased again by 0.4% instead of the expected 0.3%, and annual growth rates remained at 4.4%, which is higher than the 4.2% forecast. Steady wage growth does not allow inflation expectations to fall, the growth of real rates does not allow the Federal Reserve to start lowering the rate this year.       The U.S. inflation index, which will be published on Wednesday, is the main event of the week and the last important data before the Fed meeting at the end of July. The markets expect an 89% probability of a quarter-point rate hike. Furthermore, the probability of another increase in November has already exceeded 30%, and the first cut is now expected only in May of next year. The U.S. dollar fell after the data release and ended the week weaker than all G10 currencies. The growth of real rates in the current conditions makes a recession in the U.S. almost inevitable.   EUR/USD The Sentix Economic Index for the eurozone has fallen for the third time in a row to -22.5 points, a low since November 2022, and expectations also remain depressed. The eurozone economy has fallen into a recession as of early July. The situation in Germany is even more depressing – the index has fallen to -28.5 points, and the possibility of improvement is ephemeral.     The ZEW index will be published on Tuesday, and the forecast for it is also negative, with a decrease from -10 points to -10.2 points expected in July. On Thursday, the European Commission will present its forecasts. Bloomberg expects that industrial production in the eurozone fell in May from 0.2% y/y to -1.1% y/y, a sharp decline that characterizes the entire eurozone economy as negative and tending to further contraction.   Under the current conditions, the European Central Bank intends to continue raising rates, and even plans to shorten the reinvestment period of the PEPP program. If this step is implemented, a debt crisis, which will put strong bearish pressure on the euro, is inevitable in the face of capital outflows to the U.S. and an expanding recession.   The net long position on the euro has hardly changed over the reporting week and amounts to just over 20 billion dollars, positioning is bullish, there is no trend. However, the calculated price is still below the long-term average and is trending downward.     The euro attempted to strengthen on Friday in light of the news, but it was unable to rise beyond the borders of the technical figure "flag", let alone higher than the local high of 1.1012. We assume that the corrective growth has ended, and from the current levels, the euro will go down, the target is the lower boundary of the "flag" at 1.0730/50. GBP/USD Updated data on the UK labor market will be published on Tuesday. It is expected that the growth of average earnings including bonuses increased in May from 6.5% to 6.8%, and if the data comes out as expected, inflation expectations will inevitably rise. As will the Bank of England's peak rate forecasts. The NIESR Institute expects that further rate increases could trigger a recession.   The cost of credit is rising, and an increase in the volume of bad debts is inevitable in an economic downturn. Inflation did not decrease in May, contrary to expectations, and remained at 8.7%, even though energy prices significantly decreased. Food inflation on an annual basis reached 18.3%, and core inflation at 7.1% is at its highest since 1992. The labor force is decreasing, and if this trend is confirmed on Tuesday, it will almost inevitably result in increased competition for staff, which will mean, among other things, the continuation of wage growth. The Bank of England has already raised the rate to 5%, with forecasts implying two more increases. What does the current situation mean for the pound?   If the economy can keep from sliding into a recession, then in conditions of rising nominal rates, the yield spread will encourage players to buy assets, leading to increased demand for the pound and its strengthening. However, if signs of recession intensify, which could be clear as soon as Thursday when GDP, industrial production, and trade balance data for May will be published, the pound will react with a decrease, despite high rate expectations. After impressive growth two weeks ago, pound futures have stalled at achieved levels, a weekly decrease of just over 100 million has no significant impact on positioning, which remains bullish.  

GBP/USD: Hawkish BoE keeps GBP/USD in the ascendancy   The Bank of England’s (BoE) surprise 50bp rate hike in June caught markets by surprise. That was partly a function of the BoE’s policy to avoid much market communication. Some argued that sterling should fall because it made the chances of a UK hard landing all the greater. We argued that very inverted yield curves are often quite positive for G10 currencies. From here, we can see GBP/USD moving towards the 1.33 area near term. But GBP is subject to the same forces that recently sunk the dollar – e.g. a soft inflation print could hurt. At the moment we look for two more BoE rate hikes – policy rate to 5.50% – but well below the 6%+ rates priced by the markets.  

FX Daily: Currencies starting to detach from bond dynamics Volatility in long-dated sovereign bonds has remained elevated, but that has almost only been mirrored in a weaker yen in FX since the start of the week. The currency market is starting to detach from short-term bond swings, but the dollar’s newfound resilience could still consolidate into Thursday’s US inflation numbers.   USD: Wait and see It’s been a slow start to the week in the currency market, with the dollar being mixed but generally supported yesterday and in today’s Asian session. We continue to observe rather elevated volatility in bond markets, with long-dated Treasury yields rising again: unsurprisingly, the only notable move in FX since the weekend has been another leg higher in USD/JPY. With the Bank of Japan normalisation still looking too remote to temper bearish pressure on the yen, USD/JPY is the most exposed G10 pair to the ongoing bond market instability, especially given some signs of resilience in US equities, which limited losses in high-beta currencies. The US data calendar only includes second-tier releases until Thursday’s CPI figures. Today, the key highlights are the NFIB Small Business Confidence Optimism Index – which is expected to rise very marginally from June – trade balance figures from June, and final wholesale inventory numbers. It will be interesting to hear what FOMC members Patrick Harker and Thomas Barkin say about the economy in two separate speeches today, especially following last week’s slightly weaker-than-expected headline payroll figures. With the exception of the yen, it appears that most G10 currencies are losing their direct exposure to swings in US bond yields. At this stage, it would probably take a larger swing in yields to cause a substantial spill-over into FX than it did before the US credit downgrade by Fitch. Still, we expect some consolidation of the dollar around current levels into Thursday’s inflation numbers.

GBP: Starting on the right foot The pound has had a good start to the week, outpacing other G10 currencies: EUR/GBP was pressing the 0.8600 support yesterday. Interestingly, this was not driven by a rebound in the Bank of England rate expectations (peak rate still seen around 5.70-5.75% in January): it appeared, instead, a mirror of supported sentiment in FX, and the pound showing its ever-increasing sensitivity to risk. There will be very little on the domestic side for GBP until Friday when GDP figures are released. Expect the pound’s beta-to-risk sentiment to remain elevated for now: in the longer run, we still think markets are overestimating BoE tightening, will have to scale down expectations and EUR/GBP can climb back to 0.87-0.88

One of the most compelling reasons offered for sterling’s fall from grace in the interwar period was the surge in international USD debt issuance. The denomination of international debt can deliver all kinds of leverage – including feeding back into trade. And one commonly hears that the composition of a central bank’s FX reserves is partially a function of the sovereign’s currency mix of international debt. Evidence suggests that the dollar very much retains its crown as the preferred issuance currency – in fact it has become even more popular for EM issuers over recent years. The euro remains a distant challenger and despite the renminbi’s entry into the SDR in 2015, the Panda bond market – international debt issued in renminbi – remains exceptionally small. It seems that both issuers and investors remain concerned over both liquidity issues and China’s capital controls.   Looking at the global level, BIS data suggests the share of USD in cross-border liabilities seems to be relatively stable, with minor declines in banks and corporates recently (Figure 21). The role of USD-denominated international debt securities has been stable in recent years (Figure 22).     The subject of the currency choice of international debt issuance bears greater scrutiny. A European Central Bank working paper from 2012 made the compelling argument that sterling’s loss of supremacy in the inter-war years was a function of the surge in international debt issuance in dollars. In fact, the first ‘Strategic Target’ for the BRICS New Development Bank is to ensure that 30% of its total financing is done in local currencies. Looking deeper into this subject, currencies other than the USD and EUR have yet to make a significant impact in international debt markets, with ‘other’ currencies outside the USD, EUR and GBP making up just 6% of the outstanding stock, or US$1.8tn (Figure 23).   When drilling down further into these ‘other’ currencies, we can see a slight uptick in the use of the CNY over the past decade from almost nothing, which shows a slight increase in interest in the renminbi from investors, issuers, and perhaps Chinese officials too. But generally, this appears to have come at the expense of less use of other G10 currencies outside the USD and remains a tiny part of the international bond universe, with just under US$200bn outstanding (Figure 24).  

FX Daily: Quiet G10 markets despite Chinese turmoil Beijing continues to fight the recent turmoil on multiple fronts: real estate, financial, and the FX market. Overnight, the PBoC set the CNY fixing with the largest gap to estimates in order to curb bearish speculation. Despite all the turmoil in China, G10 volatility has remained capped, and this is probably why Japanese authorities are not intervening.   USD: Chinese authorities go all in to defend the yuan Developments in the distressed Chinese financial and property sector are emerging as the most prominent driver for market sentiment, especially after the Fed minutes proved to have limited implications for central bank expectations and developed market calendars are quite light. Overnight, Chinese authorities turned their focus on the FX market, deploying what is now regarded as the biggest defence of the yuan via fixing guidance on record. The People's Bank of China (PBoC) fixed USD/CNY at 7.2006, significantly below the average estimate of 7.305, which marks the largest gap compared to the estimate since the poll started in 2018. Today’s PBoC move follows yesterday’s reports that state-owned banks were asked by Chinese authorities to step up yuan interventions to reduce FX volatility. We could also see a cut in FX reserve requirements, often considered as a tool to avert sharp CNY depreciation. So far, the spillover into G10 currencies has been limited. The highly exposed AUD is down 1.4% this week, a relatively contained slump considering the amount of bad news that has piled up in the past few days. This is probably a signal of how AUD was already embedding a good deal of negatives related to China and how markets are expecting government intervention to avert black swan scenarios. This morning, the emergency yuan fixing has left FX markets quite untouched, with the exception of USD/JPY trading on the soft side, likely due to Japan’s service inflation hitting 2% for the first time in 30 years overnight. Incidentally, the pair is well into FX intervention territory but is probably missing enough volatility to worry Japanese officials. Still, the oversold conditions of JPY and the threat of interventions are likely going to exacerbate any USD/JPY downside corrections. The US calendar is empty today and the focus will likely be on bond market dynamics after back-end yields touched fresh multi-year highs yesterday. The combined effect of high yields and growing risks in China suggests the balance of risks is moderately tilted to the upside for the dollar. A return to 104.00 in DXY remains a tangible possibility in the coming days.

FX Daily: Economic resilience keeps dollar ‘expensive’ Our short-term fair value model indicates the dollar is overvalued against all G10 currencies, but recent price action suggests it will take some poor US activity data to prompt a USD correction. That may not happen this week, as developed market calendars are quite dry. Elsewhere, the Reserve Bank of Australia paused, but the AUD demise looks overdone.   USD: Comfortably overvalued With US trading halted yesterday for the Labour Day holiday, global FX markets started the week on a very quiet tone after Friday’s big swings. In short periods like this one where attention temporarily shifts away from the US, developments in China emerge as the main driver for global sentiment. Yesterday, hopes of fiscal stimulus triggered a rebound in Chinese property stocks, but a below-consensus read in the Caixin Services PMI overnight generated fresh pressure on Asian equities. While the equity compartment appears to respond more symmetrically to good and bad news coming from China, the currency market remains more responsive to negative developments, as the ongoing period of dollar strength contributes to limit gains for most Asian EMFX. More specifically, the renminbi still faces pressure from easing monetary policy in China, to which the People's Bank of China (PBoC) has recently paired a cut to the FX reserve ratio requirement to try and insulate the currency-depreciation effects. This morning, we are seeing USD/CNY trading higher after the poor PMIs and re-testing the 7.30 area, which has been the line in the sand for the PBoC. On the US front, we discussed in yesterday’s FX Daily how this week’s data calendar looked unlikely to radically alter the narrative of US economic resilience, which has been the foundation of recent dollar strength. Today’s calendar is quite light, only including July’s factory orders. From a technical point of view, we must note that the dollar’s outperformance in August was not entirely justified by market drivers (i.e. relative rates, equity, and commodity dynamics). Our short-term fair value model shows some dollar short-term overvaluation against all G10 currencies, ranging from quite moderate for GBP (less than 1%) to quite stretched for Scandies (above 3%). Still, one characteristic of the recent dollar price action is that it has taken poor US data to initiate any substantial correction, and we suspect a deterioration in the economic outlook remains the only real path for the mis-valuation gap to be closed. What this gap is telling us now is that the dollar correction, once the US data turn, can be quite rapid and substantial.    Francesco Pesole

At -0.78 (vs -0.83 last week) our Risk Index has pulled back a little from elevated levels indicating significant risk-seeking behaviour by investors. The downward trend in the Index is decelerating. The pillars of the recent improvement in risk sentiment are (1) slowing US inflation and (2) investors’ hope that the Fed is likely finished hiking rates or very close to the end of its tightening cycle. Some recent events have dented this hope, including rising food prices on the back of El Nino and higher oil prices on the back of Saudi Arabia & Russia deciding to extend their voluntary production cuts. Higher food & energy prices threaten a re-acceleration in inflation and at the very least high rates for longer or worse a return to Fed rate hikes. Today’s US headline inflation data will be supported by higher energy prices, which will leave investors focusing on the core inflation data for evidence of further deceleration in inflation. Investors are understandably nervous ahead of this data release. The largest contributors to the rise in our Risk Index were rising Sovereign-EM spreads as well as the outperformance of cyclical stocks by defensive stocks. Rising FX market volatility also contributed to the rise in the Index. Falling credit spreads and gold prices restrained the rise in our Risk Index. The CAD is the G10 currency most sensitive to our Risk Index, followed by the GBP and EUR. These currencies are negatively correlated with the Index. The JPY & SEK are the most positively correlated currencies with the Index.        

A disappointing set of domestic economic data sent the yen lower against the dollar once again last week, with the Japanese currency opening trading this week around the 145 level. Expectations for the first Bank of Japan interest rate hike have continued to be pushed further into the future amid signs of an easing in wage pressure and a drop in inflation. Last week’s earnings data for November was a massive miss, with wages growing by only 0.2% year-on-year, the lowest rate since December 2021 and well below the +1.5% consensus. Bank of Japan officials have placed heavy emphasis on earnings data in recent communications. The upcoming annual ‘Shuntō’ salary negotiations, which conclude in March, will be key in determining the timing of the first hike. As things stand, a strong wage negotiation will likely be needed to convince investors that tightening will commence soon, with swaps now assigning only around a one-in-three chance of a first move in April. National inflation data will be the focus this week, with the December data due on Thursday.   CHF We recently said that it might be difficult for the franc to hold onto its gains and, indeed, the currency sold off last week and was among the worst performers among the G10 currencies. We continue to view the franc as expensive, and believe that more weakness could be in store in the coming quarters, particularly should the Swiss National Bank begin to shift its attention towards supporting the country’s growth outlook. We don’t view the recent uptick in inflation as something that could potentially prevent the SNB from delivering a dovish pivot, particularly as both measures of inflation remain firmly within target. The focus this week should be on external news, although Thursday's speech by SNB President Jordan in Davos will also be worth following.

The Norwegian krone appreciated against the euro last week, and was by far and away the best performer among the G10 currencies. We largely attribute this outperformance to the increase in global oil prices. Brent crude futures rose above the $80 a barrel level for the first time this year at one stage last week, which is clearly bullish for the Norwegian currency due to its dependence on the commodity.     Wednesday's inflation data also provided some modest support for NOK, as this provided some support for the aggressive stance taken by Norges Bank. Headline inflation remained unchanged at 4.8% in December, remaining at its highest level in three months and in line with market expectations, while core inflation fell to 5.5%. Despite the drop in underlying inflation, it is still too high to be consistent with the central bank's target, supporting the notion that rates are likely to remain high for some time, as warned by Norges Bank in December.