USD: Expect the dollar to remain bid in next week’s July CPI
G3 FX volatility is stabilizing at lower levels as we enter deep into the summer months. A half-decent US earnings season has seen a modest improvement in investor sentiment and investors are starting to chip away at carry trades. In the emerging market space, it was a generally good week for sovereign credits, with Turkish hard currency bonds posting solid gains. Latin FX, where some of the highest carry in the world are located, is also enjoying a modest recovery. The yields implied across 3-month FX forwards of 13% in Brazil and 9.5% in Mexico are quite tempting if you think markets can settle into a quiet August.
On that note, the Fed’s tightening cycle pricing looks pretty stable for the end of this year in the 3.25-3.50% region. And this week’s pullback from the Fed could limit the decline in easing expectations next year. Today’s release of July NFP data should fuel this story. Our team sees a slight downside risk to the consensus of a 250,000 increase. But unless average hourly earnings fall sharply (expected 0.3% MoM, 4.9% YoY), it looks like a lot too early to conclude that the Fed’s battle against inflation is over. And another 9% YoY US CPI release next week will prevent that as well.
Overall, this should keep dollar supply near highs. Over the past year, the dollar has risen ever so slightly on the back of NFP releases. Those in the currency markets looking for carry opportunities will likely turn to the euro or the yen to fund currencies – where the outlook for both looks soft. DXY must remain bid within a range of 106-107.
Employment data will also be released in Canada today. Unlike the US, last month’s numbers (for June) were a bit grim, with employment down 43,000, but we expect a decent reading today (consensus is centered around + 15,000), with an unemployment rate that could actually stay below 5.0% . This could offer some support for the CAD, although a decisive break below 1.2800 may not be an option as the USD could also remain bullish after the NFP release. We doubt today’s numbers will derail the Bank of Canada’s tightening plan, although a more gradual approach after last month’s sharp 100bps hike seems warranted: we expect 50bps in September.
EUR: Forecast profile revised downwards
Yesterday we downgraded our multi-year EUR/USD profile. We have been bearish on EUR/USD this year, but clearly not bearish enough. And our previous forecast of 1.08 for the end of the year was starting to paint us as “bullish” – which seems unsustainable unless there is a major change in European policy that could reverse the massive negative income shock of rising energy prices. According to the latest news from Gazprom, three other turbines (in Russia) may also require maintenance. There seems to be little hope of a resumption of Russian gas supplies to Europe anytime soon.
Barring a big miss in the US NFP numbers today, and a much weaker average hourly earnings number than expected, we suspect EUR/USD will struggle to break the 1.0280/10300 zone. today.
We got it wrong with our call to the pound yesterday, where EUR/GBP rose 0.5/0.8% as the Bank of England announced the grim news that the UK economy would contract for seven consecutive quarters starting in 4Q22. But the BoE’s key rate could well rise to 2.25% in September and a 150bp spread over the ECB’s key rate should provide some protection for the pound – at least against the beleaguered euro. .
RON: National Bank of Romania will close rate gap with ECO
Today we have a policy meeting from the National Bank of Romania (NBR) including rate decisions and the presentation of a new forecast. Valentin Tataru in Bucharest expects a further 100 basis point rate hike to 5.75%, which is still the lowest rate in the CEE region. The inflation forecast should show a higher trajectory again, but the changes should not be significant. Our call is in line with the polls, but the markets have recently been calling for more and more monetary tightening. After the last meeting in July, the spread between the NBR key rate and 3M Robor fell from 270bp to 170bp. Today, however, the spread is a record 320 bps. This reflects both the continued lack of liquidity in the money market and growing expectations of NBR rate hikes. In addition to August, the central bank organizes two other policy meetings: in October and November. Today’s rate hike should be the last big hike in our view, and the next meeting should already bring smaller steps leading the terminal rate to 6.50% at the end of this year.
Despite all this, the forex market remains intact. For the leu, the 4.95 EUR/RON line remains impenetrable, entirely under the control of the central bank. Although the leu has managed to drop a little lower in recent days, the fundamentals do not suggest much reason to appreciate, quite the contrary. On the weaker side, however, the NBR is waiting to prevent any depreciation of the RON that would threaten inflationary pressures in the economy with the biggest FX pass-through in the CEE. And we believe that nothing will change in the NBR’s FX strategy until at least the end of this year.
CZK: the koruna is the key to the monetary policy of the Czech National Bank
The Czech National Bank (CNB) left interest rates unchanged yesterday, in line with our expectations. The new forecast has resulted in an upward revision to GDP growth for this year and a downward revision for next year. More interesting, however, is the central bank’s view on inflation. It should peak at 20.0% year on year in the coming months while remaining above 9% on average next year. Under these conditions, the CNB’s new forecast sees rates peak at the current level of 7% and even implies a drop in rates from 4Q. In our view, however, the key issue is corona and depreciation pressures.
As long as the CNB keeps the krone in check, we believe that further rate hikes are not in play. Thus, the main question is where is the new board’s pain threshold for the increase in the cost of foreign exchange interventions. This is very difficult to assess at the moment given that we have heard little about the new board so far, but our best guess is above CNB’s 30% foreign exchange reserve level, which is far from the current level of 12% (according to our calculations). Thus, we expect the krone to remain at current levels of 24.50-24.70 EUR/CZK and the key will be global developments, which could trigger a sell-off in emerging market currencies should risks materialize. . This would imply too painful a cost for the CNB in terms of loss of foreign exchange reserves.