(Due an extended business
trip, this weekend’s commentary has been consolidated into one note)
There are a few main themes in driving
the foreign exchange market that may be useful noting as we begin the second
half of Q1. The two overarching considerations are steady US warnings of
a pending Russian invasion of Ukraine and adjustment of interest rate
expectations amid rising inflation in many countries, even if not China and
Japan, the world’s second- and third-largest economies.
One can despise the authoritarian regime
in Moscow, but one needs to recognize the perverse incentives. NATO will not
accept a member whose borders are disputed. Moscow does not want
Ukraine to join NATO. It follows like night from day that by
threatening Ukraine’s border, Russia effectively keeps Ukraine out of
NATO. In addition, many observers insist on linking the type of
regime the rules Moscow with its geographic national interest. Yet
surely even a casual understanding of history, one grasps the strategic
importance of the Ukrainian plains to Russia’s security.
Heightened inflation and the easing of the
pandemic restrictions have turned the monetary cycle. There is
little doubt that the US and Canada are going to join the UK and Norway who
have already begun their adjustment process. The Reserve Bank of New
Zealand is likely to deliver its third hike in the cycle in the week
ahead. Despite a series of stronger than expected US data (January
CPI, retail sales, and industrial production), the swaps market has cut the
odds of a 50 bp hike by more than half to less than 40%. Formal and
informal surveys show than many expect the US inflation is likely to ease,
perhaps starting in March or April. An acceleration of the pace of
Fed hikes seems more likely if CPI does not begin rolling over.
As Vice-Chair of the FOMC, the NY
Fed President has a permanent vote on the FOMC. Williams
seemed to speak for the leadership when he said before the weekend that there
was no compelling case for a “big step” in March. Moreover, for a
Federal Reserve that recognizes the significance of the disparity of wealth and
income and seemed to put an emphasis on the “maximum and inclusive employment,”
it will be raising rates while real earnings are falling.
Japan’s Q4 deflator and the January CPI
show that even at this stage deflationary forces persist. They are
being masked by higher energy and commodity price, which is sparking a negative
term of trade shock. It puts the Bank of Japan in a difficult
position. It does not think tightening financial conditions is
appropriate so it will have to defend the 0.25% cap on the 10-year bond
yield. The yield is rising as the price of capital is rising across
world.
The European Central Bank and the Reserve
Bank of Australia continue to push against market expectations for early rate
hikes. The
ECB holds an informal meeting on February 24. It appears that
a consensus is emerging to modify the asset purchase plans to allow for an
earlier rate hike if necessary. The March 10 meeting will have
updated forecasts and new forward guidance.
The 2-10-year yield curve in the
Anglo-American economies (US, UK, Canada, and Australia) flattened so far this
year. Australia’s
has flattened the most—around 45 bp. The curve has flattened by 31
bp in the US, and a little less than 20 bp in the UK. Canada’s
2-10-year curve has flattened by nearly 10 bp. On the other hand,
the Germany curve has steepened by about 20 bp, while Italy’s curve is almost
50 bp steeper than it began the year. The difference between the two
and 10-year yield in Japan edged wider (less than 10 bp). China’s
2-year yield has fallen by almost 20 bp, while the 10-year yield has risen by
three basis points this year.
China may have removed its supportive
efforts too early and has again returned the punchbowl. Its yield primum on
10-year borrowing over the US has narrowed, which may deter foreign investors,
especially those segments that saw it as a relative-valued trade. On
the other hand, equities, especially outside of property developers and
technology seem to be attracting international interest. Earlier in the year, Chinese officials seemed to caution against
pressing the yuan higher, and it even raise the reserve requirements for
foreign deposits. However, in recent sessions, the PBOC’s dollar
reference rate was lower than the market expected.
Let's turn to the currencies
themselves.
Dollar Index: A range of roughly 95.65-96.50 was carved
last week. It essentially flat on the week, which itself is impressive given
the swing away from a 50 bp hike in March and a 10 bp decline in the implied
yield of the December Fed funds futures. It was the first weekly
decline since the end of last November. The high for the week (and month,
so far) was set at early and in last three sessions chopped up to around the
middle of the range. It closed slightly above 96.00 on the week. The
range could be extended by 0.50 in either direction without being a strong
signal. The MACD has flatlined, while the Slow Stochastic is trending
higher.
Euro: The euro bottomed on February 14
near $1.1280 and recovered to almost $1.1400 by the middle of the week. The
euro closed the week at a four-day low, a little above $1.1320. The
long-holiday weekend in the US within the context of the heightened tensions in
Eastern Europe may have weighed on the euro and risk appetites more
broadly. The MACD looks to have turned lower, and the Slow Stochastic is
trending down. It takes a break of the $1.1260 area to warn of a possible
test on last month's low near $1.1120. The economic data highlight is the
preliminary February PMI. It will be released on Monday when the US is on
holiday. The easing of the virus may have helped services rebound, while
manufacturing likely remained at elevated levels (58.7 in January). That
may be sufficient for the composite to rise for the first time since November
and only the second time since last July.
Japanese yen: The geopolitical tension and sharp
losses in US stocks sent the greenback to two-week lows slightly below
JPY114.80 before the weekend. While the settlement was just above JPY115.00, it
was below the 20-day moving average (~JPY115.10) for the second consecutive
session. The trendline that connects the January 24 low (~JPY113.45), the
February 2 low (~JPY114.15), and the February 14 low (~JPY115.00) was violated
on a closing basis on February 17 and was unable to resurface it ahead of the
weekend. It begins the new week a little below JPY115.50. The exchange
rate continues to be more correlated with the S&P 500 than the 10-year
yield. Over the past 30 sessions, the correlation of the changes is about
0.55 for the S&P 500 and the exchange rate compared with practically zero
for the 10-year Treasury yield and the exchange rate. The momentum
indicators are trending lower. Initial support is seen around
JPY114.60. Below there, the band of support in the JPY114.00-JPY114.15 may
be more formidable. The economic data highlight in the week ahead is the
preliminary PMI reading. Recall in January, as new covid measures were
taken, the composite slipped below the 50 boom/bust level. After growing
at an annualized rate of 5.4% in Q4 21, the Japanese economy may be fortunate
to grow 1% in Q1 22.
British Pound: Sterling may be added to the list
of false breaks seen in the foreign exchange market so far this year. It
managed to settle above $1.36 on February 17 for the first time in nearly a
month, but no follow-through buying materialized, and it settled a little below
there the following day. Despite a string of strong data, including CPI,
retail sales and employment, over the past week, the swaps market saw a sharp
decline in the perceived likelihood of a 50 bp hike when the BOE meets again in
mid-March. The odds have fallen from 75% chance to a little more than
35%. The pullback ahead of the weekend pared the week's gains, but still
managed to extend its advance for the third consecutive week. Still, the
cable still appears to remain rangebound, and most activity continues on the
$1.35-handle. Sterling continues to trend higher against the euro.
Through last week, it has risen in nine of the past 11 weeks.
Year-to-date, sterling is the strongest of the major currencies, rising by
about 0.5%. The euro has fallen by about the same amount. Initial
euro support is seen in the GBP0.8285-GBP0.8300 area. As covid
restrictions were relaxed, the UK services sector is likely to improve, and
this is expected to be picked up by the PMI.
Canadian Dollar: The US dollar has been confined to
a fairly clear range against the Canadian dollar this month. The
CAD1.2650-CAD1.2660 band marks the lower end, and the cap is CAD1.2800.
The correlation between the exchange rate and the risk-environment (S&P 500
proxy) has fallen sharply in recent weeks. The 30-day rolling correlation
is a little more than 0.25, down from nearly 0.75 at the end of last
year. On the other hand, the correlation with the two-year yield
differential has risen to about 0.4 from around 0.05 at the end of 2021. The
Slow Stochastic is trending lower, but the MACD has flatlined. The
economic calendar is light next week. The efforts by the Canadian
government to quash the protests, using financial institutions and the expanded
police powers, may eventually prevail but at a significant cost for the
minority Liberal government. Nevertheless, the domestic political
developments appear to be having minimal impact on the exchange rate.
Meanwhile, unlike the US and UK, the swaps market did not change much for
Canada much last week. The odds of a 50 bp rate hike were steady a little
below 50%.
Australian Dollar: The Antipodean currencies led the
majors higher last week (New Zealand dollar ~0.75% and Australian dollar
~0.55%). The Aussie's high for the week was set ahead of the weekend a
little below $0.7230, but the risk-off that prevailed saw it settle at a
three-day low slightly above $0.7175. The MACD is rising gradually and is near
the year's high. The Slow Stochastic appears to have begun rolling
over. This month's high was set near $0.7250, but the market shows little
inclination to challenge it. Initial support is seen around $0.7140, and
a break could spur losses toward $0.7100. The Australian dollar rose to
eight-month highs against the New Zealand in the middle of last week near
NZD1.08. It fell back to nearly NZD1.07 before the weekend. A top
of some import appears to be in place. While some support may be
seen around NZD1.0660, the first significant test could be closer to NZD1.0575,
the low from mid-January. The flash composite PMI may rebound from
the collapse in January (to 46.7 from 54.9). Given the importance the
Reserve Bank of Australia has attached to wage growth, the Q4 21 in the middle
of next week will likely draw attention. Recall that the four-quarter
moving average rose by 2.2% in 2018 and 2019. It fell back to 1.7% in
2020 and that is where it was in Q3 21. With the anticipated 0.7%, the year-over-year
rate will increase to 2.4%, but the four-quarter average will still below
2%. The swaps market shifted away from a June hike. The first hike
is fully discounted for July, and 140 bp of tightening over the near
12-months.
Mexican Peso: The US dollar fell for the third
consecutive week against the Mexican peso. The 1.20% decline was the
largest in two months. Since the end of last November, the greenback has
risen in only two weeks against the peso. Consider that the four-week US T-bill
pays an annualized rate of one basis point while the one-month cetes pays a
little more than 6%. The carry attracts. Also, the peso is a liquid
proxy for emerging market currencies more broadly. The JP Morgan Emerging
Market Currency Index is up about 2% so far this year, while the peso has
gained 1.2%. The swaps market has nearly 200 bp of tightening priced in
for Mexico over the next 12 months. After flirting with it at least half
a dozen times this year, the dollar finally was sold through the 200-day moving
average (~MXN20.34) in the middle of last week and has now closed below it for
three consecutive sessions. The MACD has rolled down, and the Slow
Stochastic has entered overextended territory. There is little chart
support ahead of the MXN20.12. On the upside a move back above MXN20.50
would suggest a low is in place. Although Mexico-'s bi-weekly CPI
(year-over-year) has remained above 7% since mid-November, it has decelerated
from 7.7% to almost 7% at the end of January. There is some risk that it
picked up again in the first half of this month. Nevertheless, less likely a 50
bp hike is in the US, the more likely a 25 bp hike by Banxico when it
meets March 24, a week after the Fed.
Chinese Yuan: For the last four sessions, the
PBOC's dollar fixing has been weaker than median in the Bloomberg survey
projected. Is it significant? At most one can say it is a reversal
of the recent relationship and may not be consistent with the comments
seemingly meant to cap the yuan earlier this year. The dollar fell by
about 0.45% against the yuan last week, the most in about 3.5 months. The
dollar is approaching CNY6.32 low of January 26, which was the lowest since
2018, when it bottomed a little below CNY6.2450. Technically, the gap
from late January (CNY6.3235-CNY6.3363) was nearly completed with the dollar's
pre-weekend loss. A break could spur a move toward CNY6.30.
China's premium over the US on 10-year rates has stabilized after hitting a
three-year low of almost 70 bp on February 10. It finished last week
closer to 85 bp, owing almost exclusively to the pullback in the US
yield. It is a light week for Chinese economic data. More
economic stimulus appears broadly expected.
Disclaimer
Reviewed by Marc Chandler
on
February 19, 2022
Rating:
