EUR USD - FUNDAMENTAL DRIVERS
EUR
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The ECB used the April meeting as a place holder meeting for the most part by not announcing any additional policy tweaks. The plans to phase out the APP into Q3 remained intact by reducing purchases from 40bln to 30bln in May and then down to 20bln in June. Markets were leaning towards a slightly more hawkish take from the bank (given recent inflation pressures), but the lack of conviction to remove the conditionality regarding the APP removal was seen as dovish. President Lagarde added to this dovish tone by explaining that Q3 has three months and IF the bank stops the APP, it could happen July, August or September. This was an important statement as the difference between a July and September end could mean the difference between a Q3 or
Q4 rate hike. The president also added to the dovish tone by stressing that risks for the economic outlook are tilted to the downside and have recently intensified with geopolitical and virus-related challenges. When asked about policy normalization, the president made a strange comment by saying it is premature to think about monpol normalisation. As the bank is currently embarking on normalization this comment seemed out of place and reaffirmed the overall dovish take from the meeting. There were the usual sources releases after the presser which said policymakers see a July hike as still possible after Thursday's meeting, which provided some reprieve. With inflation >7% and growth slowing, the June meeting which accompanies staff economic projections will be critical for markets to solidify whether expectations of 1 or 2 hikes this year is correct or not.
2. Economic & Health Developments
Growth differentials still favour the US over EU capital flows, but differentials have turned positive against the UK. Given growing stagflation fears the ECB is in a tough spot, being forced to normalize policy to try and combat inflation but could as a result damage growth. Ongoing EU fiscal discussions to possibly allow ‘green bonds’ NOT to count against budget deficits remains in focus, alongside debt issuance for energy purchases. If approved, it will offer a flood of fiscal support which would be positive for the EUR and EU equities. Geopolitics The EUR pushed lower aggressively after initial geopolitical scares but have been trying to carve out a base. Proximity to the war and the impact of sanctions remains a risk if the situation deteriorates. With lots of negatives already priced, chasing lows on bad news is not as attractive as chasing the EUR higher on good news.
3. CFTC Analysis
Very bearish signal from recent positioning update as all three major categories saw sizeable net-short weekly changes. The price action throughout the week has reflected this change in sentiment quite well.
4. The Week Ahead
The data is extremely light for the Eurozone next week with no major data events to take note of apart from final PMI data (which is unlikely to create a lot of volatility). Thus, the biggest drivers for the EUR in the week ahead will be ECB speak, Geopolitics and of course the outcome of the FOMC. For the FOMC, the reaction in the USD will largely impact G10 FX across the board, and since the DXY is close to 60% weighted to the EUR that means any big USD moves will be important to watch for the EUR. For ECB speak, markets will be looking for any further comments about the possibility of a July rate hike by the ECB (STIR markets pricing in a 94%
probability of a July hike already). Any comments, especially from dovish ECB members could see some upside, but with a hike almost fully priced there might not be much more miles left in that tank. With a hike almost fully priced, the biggest risk from ECB speak in the week ahead is comments that sees markets pricing out a hike for July and could see some downside if that’s the case. For Geopolitics, the Eurogroup meetings will be watched closely for any further news on a potential oil embargo (with Germany reportedly warming up to the idea this week). It’s important to see the details of any embargo to assess the likely impact to the EUR. For example, will it be an immediate stop or gradual (if gradual how long), will it be specific amounts or a more phased approach, have the EZ already sourced alternative supply or not, what type of premium are they expected to pay if they have sourced from other suppliers. All these details will be necessary to be able to quantify how negative any embargo will be and how that will likely then impact the EUR.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
In March the Fed delivered on a 25bsp hike as expected with Fed’s Bullard the only dissenter voting for a 50bsp hike. The Dot Plot saw a big upgrade from 3 hikes (Dec) to 7 hikes for 2022, with the FFR seen reaching 2.75%- 3.0% in 2023 before falling in 2024. They did however lower their neutral rate from 2.5% to 2.4% which were a negative. Inflation forecasts for 2022 were raised to 4.1% (previous 2.7%) but med-term inflation saw less aggressive upgrades. Even though the overall message and projections were hawkish, the fact that GDP estimates were lowered to 2.8% from 4.0% shows the Fed expects their actions to impact demand and also reflect some of the recent geopolitical uncertainties. The Fed didn’t share new details on QT but noted that the decision to start selling assets will be made at a coming meeting (markets consensus sees a July start as likely) and added that good progress in QT discussions means a May announcement is likely. During the presser the Chair expressed his view that the economy is doing really well and, should be more than able to withstand the incoming rate hikes (a very similar situation like we had in 4Q18). When asked whether 50bsp hikes could be on the table, the chair explained that the FOMC has not made decision to front-load hikes and will keep an eye on incoming inflation data to determine their policy actions going forward, but of course added that every incoming meeting was live. Overall, the Fed was hawkish, but due to very strong pre-positioning and close to peak hawkishness priced for STIR markets the meeting saw a ‘sell-the-fact’ reaction across major asset classes.
2. Global & Domestic Economy
As the reserve currency, the USD’s global usage means it’s usually inversely correlated to the global economy and global trade. The USD usually appreciates when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Thus, current expectations of a cyclical slowdown are a positive driver for the Dollar. Incoming data will be watched in relation to the ‘Fed Put’ as there are many similarities between now and 4Q18, where the Fed were also tightened into a slowdown. If growth data slows and the Fed stays hawkish it’s a positive for the USD, however if the Fed pivots dovish that’ll be a negative driver for the USD.
3. CFTC Analysis
Aggregate USD positioning remains close to 1 standard deviation above the mean, and close to prior tops where the USD topped out in previous cycles. That does not change the bullish outlook for the USD in the med-term but means that we would wait for pullbacks before initiating new longs with price at new cycle highs.
4. The Week Ahead
The main event for the week ahead will no doubt be the FOMC meeting, but we’ll also get ISM PMIs as well as the April jobs print coming our way. For the FOMC, we think the Fed has set themselves a very high hawkish bar going into the meeting. STIR markets are pricing in 3 back-to-back 50bsp hikes, as well as an earlier start to QT (95bn p/m). On the language side, recent Fed speak has seen even the doves find their inner hawks by talking up very aggressive policy tightening. So, with all of that as the baseline going into the meeting, it means the Fed would need to hike 75bsp and up the expected QT pace to really surprise markets. With the USD and Yields at cycle highs and equities at cycle lows, that increases the chances of some sell-the-fact reactions. This would be our preferred strategy for the USD going into the week. Then we also have the data where the ISM PMI data will be closely watched for further clues of whether growth is slowing faster than expected. On the jobs side, the impact of the NFP will most likely be dictated by the outcome of the FOMC decision. If the Fed manages to surprise on the hawkish side (seems unlikely) a beat in jobs won’t do much to change that, but a miss can certainly do a lot to stir the pot (even more so if the Fed decision is interpreted as ‘less hawkish’.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The ECB used the April meeting as a place holder meeting for the most part by not announcing any additional policy tweaks. The plans to phase out the APP into Q3 remained intact by reducing purchases from 40bln to 30bln in May and then down to 20bln in June. Markets were leaning towards a slightly more hawkish take from the bank (given recent inflation pressures), but the lack of conviction to remove the conditionality regarding the APP removal was seen as dovish. President Lagarde added to this dovish tone by explaining that Q3 has three months and IF the bank stops the APP, it could happen July, August or September. This was an important statement as the difference between a July and September end could mean the difference between a Q3 or
Q4 rate hike. The president also added to the dovish tone by stressing that risks for the economic outlook are tilted to the downside and have recently intensified with geopolitical and virus-related challenges. When asked about policy normalization, the president made a strange comment by saying it is premature to think about monpol normalisation. As the bank is currently embarking on normalization this comment seemed out of place and reaffirmed the overall dovish take from the meeting. There were the usual sources releases after the presser which said policymakers see a July hike as still possible after Thursday's meeting, which provided some reprieve. With inflation >7% and growth slowing, the June meeting which accompanies staff economic projections will be critical for markets to solidify whether expectations of 1 or 2 hikes this year is correct or not.
2. Economic & Health Developments
Growth differentials still favour the US over EU capital flows, but differentials have turned positive against the UK. Given growing stagflation fears the ECB is in a tough spot, being forced to normalize policy to try and combat inflation but could as a result damage growth. Ongoing EU fiscal discussions to possibly allow ‘green bonds’ NOT to count against budget deficits remains in focus, alongside debt issuance for energy purchases. If approved, it will offer a flood of fiscal support which would be positive for the EUR and EU equities. Geopolitics The EUR pushed lower aggressively after initial geopolitical scares but have been trying to carve out a base. Proximity to the war and the impact of sanctions remains a risk if the situation deteriorates. With lots of negatives already priced, chasing lows on bad news is not as attractive as chasing the EUR higher on good news.
3. CFTC Analysis
Very bearish signal from recent positioning update as all three major categories saw sizeable net-short weekly changes. The price action throughout the week has reflected this change in sentiment quite well.
4. The Week Ahead
The data is extremely light for the Eurozone next week with no major data events to take note of apart from final PMI data (which is unlikely to create a lot of volatility). Thus, the biggest drivers for the EUR in the week ahead will be ECB speak, Geopolitics and of course the outcome of the FOMC. For the FOMC, the reaction in the USD will largely impact G10 FX across the board, and since the DXY is close to 60% weighted to the EUR that means any big USD moves will be important to watch for the EUR. For ECB speak, markets will be looking for any further comments about the possibility of a July rate hike by the ECB (STIR markets pricing in a 94%
probability of a July hike already). Any comments, especially from dovish ECB members could see some upside, but with a hike almost fully priced there might not be much more miles left in that tank. With a hike almost fully priced, the biggest risk from ECB speak in the week ahead is comments that sees markets pricing out a hike for July and could see some downside if that’s the case. For Geopolitics, the Eurogroup meetings will be watched closely for any further news on a potential oil embargo (with Germany reportedly warming up to the idea this week). It’s important to see the details of any embargo to assess the likely impact to the EUR. For example, will it be an immediate stop or gradual (if gradual how long), will it be specific amounts or a more phased approach, have the EZ already sourced alternative supply or not, what type of premium are they expected to pay if they have sourced from other suppliers. All these details will be necessary to be able to quantify how negative any embargo will be and how that will likely then impact the EUR.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
In March the Fed delivered on a 25bsp hike as expected with Fed’s Bullard the only dissenter voting for a 50bsp hike. The Dot Plot saw a big upgrade from 3 hikes (Dec) to 7 hikes for 2022, with the FFR seen reaching 2.75%- 3.0% in 2023 before falling in 2024. They did however lower their neutral rate from 2.5% to 2.4% which were a negative. Inflation forecasts for 2022 were raised to 4.1% (previous 2.7%) but med-term inflation saw less aggressive upgrades. Even though the overall message and projections were hawkish, the fact that GDP estimates were lowered to 2.8% from 4.0% shows the Fed expects their actions to impact demand and also reflect some of the recent geopolitical uncertainties. The Fed didn’t share new details on QT but noted that the decision to start selling assets will be made at a coming meeting (markets consensus sees a July start as likely) and added that good progress in QT discussions means a May announcement is likely. During the presser the Chair expressed his view that the economy is doing really well and, should be more than able to withstand the incoming rate hikes (a very similar situation like we had in 4Q18). When asked whether 50bsp hikes could be on the table, the chair explained that the FOMC has not made decision to front-load hikes and will keep an eye on incoming inflation data to determine their policy actions going forward, but of course added that every incoming meeting was live. Overall, the Fed was hawkish, but due to very strong pre-positioning and close to peak hawkishness priced for STIR markets the meeting saw a ‘sell-the-fact’ reaction across major asset classes.
2. Global & Domestic Economy
As the reserve currency, the USD’s global usage means it’s usually inversely correlated to the global economy and global trade. The USD usually appreciates when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Thus, current expectations of a cyclical slowdown are a positive driver for the Dollar. Incoming data will be watched in relation to the ‘Fed Put’ as there are many similarities between now and 4Q18, where the Fed were also tightened into a slowdown. If growth data slows and the Fed stays hawkish it’s a positive for the USD, however if the Fed pivots dovish that’ll be a negative driver for the USD.
3. CFTC Analysis
Aggregate USD positioning remains close to 1 standard deviation above the mean, and close to prior tops where the USD topped out in previous cycles. That does not change the bullish outlook for the USD in the med-term but means that we would wait for pullbacks before initiating new longs with price at new cycle highs.
4. The Week Ahead
The main event for the week ahead will no doubt be the FOMC meeting, but we’ll also get ISM PMIs as well as the April jobs print coming our way. For the FOMC, we think the Fed has set themselves a very high hawkish bar going into the meeting. STIR markets are pricing in 3 back-to-back 50bsp hikes, as well as an earlier start to QT (95bn p/m). On the language side, recent Fed speak has seen even the doves find their inner hawks by talking up very aggressive policy tightening. So, with all of that as the baseline going into the meeting, it means the Fed would need to hike 75bsp and up the expected QT pace to really surprise markets. With the USD and Yields at cycle highs and equities at cycle lows, that increases the chances of some sell-the-fact reactions. This would be our preferred strategy for the USD going into the week. Then we also have the data where the ISM PMI data will be closely watched for further clues of whether growth is slowing faster than expected. On the jobs side, the impact of the NFP will most likely be dictated by the outcome of the FOMC decision. If the Fed manages to surprise on the hawkish side (seems unlikely) a beat in jobs won’t do much to change that, but a miss can certainly do a lot to stir the pot (even more so if the Fed decision is interpreted as ‘less hawkish’.
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