Too early to jump on the bearish dollar boat
The dollar correction could extend a bit further today as the slowdown in the US CPI could further bolster risk sentiment. However, Fed rate expectations should not be affected, and optimism about the conflict in Ukraine and lower gas prices could be misplaced or too premature, so the dollar could stabilize or rally further. late in the week.
USD: Another leg lower with slowing US CPI?
An extension of supported risk assets kept the dollar under pressure early this week. In particular, European sentiment seems to be rebounding quite strongly, largely thanks to falling gas prices and some market optimism regarding the evolution of the Russian-Ukrainian conflict. All of this likely caused some squared effect on the overbought dollar, which broadened the scope of the dollar’s decline.
The question is whether this correction is sustainable and the dollar actually peaked last week. In our view, the narratives behind the recent currency moves are not strong enough for the strong bearish call on the Dollar yet. First, because lower gasoline prices could actually be linked to lower levels of mandatory usage, which would be rather bad news for the eurozone economy given the centrality of the manufacturing sector. Second, market optimism around a ceasefire based on Ukraine’s recent counteroffensive may be premature. Third, the dollar can still count on a strong domestic story, both on the growth side and on the monetary policy side, as markets have now cemented their expectations for a 75 basis point Fed hike in September and a federal funds rate of 4.00% in early 2023.
Today’s US CPI data for August, however, is a risk event for the Dollar. The consensus is centered on a deceleration in headline inflation from 8.5% to 8.1%, mainly due to lower gasoline prices. Core inflation could instead accelerate above the 6.0% mark against 5.9% in July. Overall, and given recent hawkish messages from Fed Chairman Jerome Powell, it seems unlikely that – barring readings significantly below consensus – expectations for Fed tightening will be materially affected by the report. on today’s CPI. That said, there is surely a possibility that a risk environment will be further bolstered by evidence of a spike in US inflation, and another dollar decline could be triggered by another strong session for global equities.
As noted above, it is too early in our view to see a more structural downtrend in the dollar, and we see a higher likelihood of stabilization or a small rally in the greenback in the second half of the week.
EUR: Equity differential on the driver’s seat
Last week, we highlighted the growing importance of relative equity performance (as an indicator of divergent growth trajectories) in the evolution of the short-term fair value of EUR/USD. Indeed, growing market optimism about Europe is fueling a rally in European equities, and the parallel rally in the Euro is keeping that FX-equity correlation very much alive.
We mentioned above how markets may have gotten bullish on the gas and Ukraine themes too soon, but the euro may also have been helped by some hawkish comments from ECB officials. Importantly, monetary policy does not play a primary role in driving short-term EUR/USD moves, and the parallel hawkish price revision in Fed expectations means that the EUR-USD swap spread USD 2-year is close to meeting its post-ECB level.
The current swap rate differential is certainly pointing to stronger EUR/USD, but for the pair to return to that differential under current market conditions, we will likely need a period of stabilization in European sentiment, which we are seeing now but could prove difficult to sustain in the weeks to come.
Today the focus will be on the ZEW survey in Germany, while no ECB speakers are scheduled. Another potential good day for risky assets if the US CPI drops could keep EUR/USD supply for now: a break above 1.0200 is possible at this point, but a return to parity the 1.0000 level remains our year-end base case for EUR/USD.
Elsewhere in Europe, the results of Sweden’s general election have yet to be announced and an official final tally may not be announced until tomorrow. However, it looks like a right-wing/far-right coalition is on track to secure a majority by a very slim margin. The SEK has been the best-performing currency since Friday, but this is in line with its high beta against European risk sentiment rather than a reaction to the election results.
GBP: the labor market remains tight
Employment data released this morning was broadly in line with consensus expectations and confirmed that the UK labor market remained quite tight. More importantly for the Bank of England, evidence that wage growth has continued to accelerate could suggest more aggressive tightening.
The GBP is trading slightly higher after this morning’s release, but is expected to have a bigger reaction after tomorrow’s CPI data. Today, the Cable is expected to move further by external engines and may remain supported, while EUR/GBP may remain in the upper half of the 0.86-0.87 range.
EEC: FX has switched the tariff pipe towards gas
Current account data from Poland, the Czech Republic and Romania will be released today. We do not expect any change in the current trend of negative balances in the region. But we don’t think this will do anything to the stronger FX in the CEE, which is already completely disconnected from the markets and only follows gas prices. Yesterday’s rate cut pushed interest rate differentials to new lows, in Poland since March this year, in the Czech Republic since December last year and in Hungary since mid-August. However, the market seems indifferent to this decision, and further declines in gas prices indicate further gains for CEE FX. We currently see the biggest gap in this relationship for the Czech koruna, which could continue its rally from yesterday below 24.50 EUR/CZK and the Polish zloty closer to 4.680 EUR/PLN. On the other hand, we see the Hungarian forint at a reasonable price at the moment and awaiting news from the negotiations with the European Commission.
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