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Currency Market Analysis

Jun 21, 2022 | Currency Market Analysis

Global Themes


Recession risks in the US have increased

The Federal Reserve’s tightening of monetary policy will very likely lead to a deterioration of US economic activity. Markets have already started positioning for the downturn and are pricing in the first rate cut from the Fed by the middle of 2023. The President of the Cleveland Federal Reserve Loretta Mester said that the risk of a recession in the US economy has increased because of the pivot in the Fed’s monetary policy. This comes at a time where leading indicators for the largest economy in the world are starting to turn south. With financial conditions tightening and consumer sentiment souring, more economists have revised down their forecasts for the US economy for 2022, with some like Nomura seeing a recession as the base case. The Japanese investment bank is not alone. The GDPNow forecast of the Atlanta Fed shows expected growth of zero percent for the second quarter of this year and the New York Fed’s model puts the change of a soft landing at just 10%. It remains unclear how a potential recession would affect the Greenback. The short-term uncertainty surrounding an economic slowdown could potentially be enough to shield the Dollar from any selling. For now, the Fed’s aggressive hiking pace for 2022 is all that FX traders are focused on.


The ECB wants to have its cake and eat it too

Following Christine Lagarde’s comments yesterday, just five days after she called for an emergency meeting, rising spreads between German and Italian yields will be dealt with via a new “anti-fragmentation” tool that could be ready before the July meeting. The new instrument could theoretically pave the way for more rate hikes without the short-term worry of higher spreads. But the ECB somehow wants to have its cake and eat it too. Lagarde has clearly laid the foundation for a potential continuation of asset purchases (dovish) beyond the first rate hike (hawkish). This could be a net-positive for the Euro in the short-term. Looking beyond the next six months, however, reveals a more mixed picture. This development will only strengthen the argument that the ECB has to defend not only its mandate of fighting inflation but keeping spreads between the core and peripheral countries at bay as well. Without any clear plan presented, markets remain skeptical. In light Monday and Tuesday morning trading, EUR/USD has been able to edge up by about 10 basis points to 1.0520. The selling pressure in the fixed income space has dragged into the new week and continues to push yields higher on both sides of the Atlantic. Stocks are attempting to rebound from a rough couple of weeks.


More tightening ahead of the BoE

Markets will likely have to price in more rate hikes from the BoE if inflation stays elevated in the medium term. The pound has only slightly profited from 2-year government bond yields reaching 14-year highs given that rates have moved even more aggressively in other countries within the G10. UK government bonds continued to sell off amidst the belief that the Bank of England would have to do more in order to rein in inflation and prop up the Pound. The central bank’s Catherine Mann said yesterday that policy makers would have to accelerate their tightening cycle to mitigate further sterling downside. Inflation is running at a 40-year high and has forced the BoE to raise interest rates five times in a row. Markets, however, are still pricing in much less tightening in the UK compared to countries like the United States, Australia, New Zealand and Canada. GBP/USD starts the week of with slight gains, after falling last week to its lowest level since the beginning of the pandemic in March 2020.  

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