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FX Daily: Cash Parked on the Sidelines

Published 08/11/2022, 11:26
Updated 16/06/2021, 12:30

The dollar remains in correction mode and the market is watching the news from China regarding the approach to its Covid-19 policy. Today's market focus will be on the US mid-term elections. We expect the Romanian central bank to raise rates by 50bp to 6.75%, which may be the central bank's last move in this hiking cycle

US Dollar: The known unknowns

The dollar remains in corrective mode as investors, very underweight in both equity and bond markets, stand ready to adjust positions on the latest headlines out of China. Here, China’s zero-Covid policy represents a ‘known unknown’ for the market and one where any significant relaxation could unleash a wall of cash parked on the sidelines in dollars. Active investors would not want to be caught out by a year-end rally in risk assets.

Some concrete news on China’s Covid policy would probably trigger more of a dollar correction, but until then FX markets will be dragged around by two key factors: central bank policy and energy prices. A recent BIS paper looking at this year’s dollar rally picks out those two factors and concludes that, with real rates still negative in many countries, it would be dangerous to be too concerned with the over-tightening of monetary policy.

Fears of over-tightening do not seem to be present in the US currently, where money markets are continuing to price the Fed cycle higher and later. Perhaps one factor we are underestimating here is that a more drawn-out Fed tightening cycle is delivering a drop in volatility and a fillip to the carry trade. Certainly, US interest rate volatility has started to drop.

For today, the focus will be on the US mid-term results. Although the immediate impact on the dollar will be muted ahead of the main event risk this week – October US CPI data on Thursday.

DXY should continue to find support this week below 110.

Euro: Staying above parity is no easy task

EUR/USD climbed back above parity yesterday, still driven by a softer dollar and relatively upbeat risk sentiment. In the eurozone, we continued to hear calls for more tightening, with European Central Bank president Christine Lagarde and Governing Council member Francois Villeroy de Galhau both maintaining a hawkish tone. We doubt, however, this is offering idiosyncratic support to the euro at this stage.

Today, the eurozone data calendar includes retail sales for the month of September, which are expected to have climbed on a month-on-month basis. ECB Governing Council member Joachim Nagel is speaking this morning, and we can surely expect more hawkish comments on his side.

While the US inflation report and the mid-term elections are two key risk events for the dollar, macro factors continue to point at a weaker EUR/USD, and we doubt that with the economic uncertainty in the eurozone ahead of the winter and a still hawkish Fed the procyclical EUR/USD will easily remain above parity in the coming weeks.

Pound Sterling: BoE Gilt sales meet lukewarm demand

Lukewarm demand at yesterday’s Bank of England 7-20Y Gilt auction saw Gilts selling off and dragging other bond markets with them. Our debt strategy has been pointing out that investor demand is for shorter-dated Gilts and that £6.25bn worth of Gilt auctions later this week will not have helped the BoE’s gilt auction. Soft demand at the auction and the subsequent Gilt sell-off did not inordinately hurt sterling, however, which seems to be settling down a little.

For today, the focus will be on some speeches from the BoE’s Huw Pill and Catherine Mann. Somewhat surprisingly, the pricing of the BoE cycle does not seem to have moved much since the immediate volatility following last Thursday’s Monetary Policy Committee meeting. And the FX market may now be wholly focused on the amount of fiscal restraint coming through on 17 November. We continue to favour the view that GBP/USD rallies over 1.15 are not sustainable.

Disclaimer: This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more

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