FX Talking - Summer of discontent keeps dollar in demand | EUR/USD | USD/JPY | GBP/USD | ING Economics

FX Talking - Summer of discontent keeps dollar in demand | EUR/USD | USD/JPY | GBP/USD | ING Economics

The global economy can now be characterised as one in which many central bankers are poised to hike rates more forcefully, even as growth prospects are being revised lower. Investors are now having to ask which economies can best withstand these tighter monetary conditions and which currency to back?

During this summer of discontent the answer to these questions largely remains the US economy and the dollar. Unlike the supply-driven inflation suffered in Europe, price rises in the US are far more a function of demand-side factors and suggest stagflation is less of a likelihood in the US than in Europe. And with no end in sight to tight energy markets, the US remains better positioned here too.

We expect the Fed to deliver at least another 175bp of hikes this year as the Fed drives real US interest rates into restrictive territory. This is not good news for global growth – but that is the point, the Fed needs to slow demand. Flatter yield curves consistent with the latter stages of the US business cycle are normally good news for the dollar.

In all this means that the dollar should stay bid this summer (1.00/1.02 is possible in EUR/USD), while USD/JPY in the 135/140 region looks ready to trigger Japanese intervention. GBP/USD can move to the low 1.20s as the BoE cycle is repriced lower and the CHF should start to outperform in Europe as the SNB guides it higher. CEE FX has become more mixed. We still favour the PLN, but HUF and now CZK look more vulnerable.

This will be a fragile environment for most EMFX – especially those most exposed to China. Here USD/CNY can still push higher taking most of $/Asia with it.

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Developed markets

EUR/USD

A long, hot summer for the euro

Current spot: 1.0476

  • Both the Fed and the ECB are in hawkish mode – both battling inflation near 8%. Both are probably happy with stronger currencies. The difference is the stagflationary shock from the war in Ukraine which makes the ECB unlikely to deliver on the 150bp of tightening priced in. There is also the issue of growth differentials and what they mean for international equity flows. These could start generating some euro under-performance.
  • EUR/USD looks biased towards the lower end of a 1.02-1.08 range this summer. It looks far too early to pick the top in the Fed cycle.
  • Higher US real rates also spell trouble for risk assets, including EM in general. This will also lend further support to the dollar

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USD/JPY

Official concern and stretched valuations may help JPY

Current spot: 134.43

  • The combination of aggressive Fed tightening (we look for at least another 175bp of Fed rate hikes this year), high energy prices and BoJ dovishness has sent USD/JPY to 135.
  • Japanese officials are now officially unhappy with the rapid pace of JPY weakness. Sensible arguments go that the BoJ cannot intervene to sell $/JPY since: a) markets are not disorderly and b) BoJ is still printing money with QQE. Yet intervention is political & one never knows whether deals get cut behind the scenes
  • We cannot rule out USD/JPY marching towards 140 given that this is a fundamentally driven, but intervention signals are flashing amber/red. Traded USD/JPY volatility can rise further.

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GBP/USD

Bank of England tightening expectations are extreme

Current spot: 134.43

  • GBP/USD looks as though it can trade back down to the 1.21/22 levels – largely on the back of dollar strength. But certainly an Unexploded Bomb (UXB) for sterling is the incredibly aggressive 175bp of tightening priced into the BoE cycle for year-end. This seems very extreme given that not all the MPC were on board with May’s 25bp hike. The 16 June BoE meeting is an event risk.
  • UK growth will struggle in 2Q, although there is increasing speculation over tax cuts coming through this Autumn – in a bid to shore up Conservative support ahead of a possible ‘23 election.
  • We doubt a Tory leadership change or Brexit tension has too much impact on sterling – a lot of bad news is already priced.

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FX Talking - Summer of discontent keeps dollar in demand | EUR/USD | USD/JPY | GBP/USD | ING Economics - 8

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