FX Daily: Russia set to cut rates further today

Reading through the release of the 4 May FOMC minutes suggests that, at that time, the Fed had nothing but confidence in the recovery and was laser-focused on getting the policy rate to neutral as quickly as possible. Indeed, there was some slight reference for the need for the policy rate to go beyond neutral and into restrictive territory. Since then US equity markets have fallen a further 8-9%, with some softening in the housing data. However, the Fed seems confident with the consumption and investment story. And tomorrow's personal consumption and core PCE deflator numbers for April should support the Fed's position that the economy is strong enough to withstand 'expeditious' tightening.

Pricing of the Fed tightening cycle has corrected 25-35bp lower since early May, but Fed speak and the US data calendar suggests those higher levels for the Fed terminal rate could easily be put back into the market - which is dollar supportive. At the same time, Chinese authorities have yet to unveil any bazooka-style support for the economy and instead are relying on a lot of local targeted measures. We do note some return of foreign portfolio flows into Chinese equity markets, but the renminbi recovery has stalled at 6.65/USD and could easily weaken again as authorities prefer a weaker currency to stimulate growth. The soft renminbi environment will continue to favour the dollar.

We prefer to see the recent DXY 3% dip as a bull market correction and favour a near-term recovery to the 103.30 area as the Fed cycle is re-priced higher again. We doubt today's US data of the revised 1Q GDP number, initial jobless claims or pending home sales will have much say in dollar pricing.

It seems the purpose of President Christine Lagarde's blog on Monday was to bring the range of ECB views back into line. Yesterday we saw ECB hawk Klaas Knot saying that he fully supports the contents of Lagarde's blog, which effectively promised 25bp hikes in July and September. The market currently prices 32bp of rate hikes for the 21 July ECB meeting and we may see that gravitating back to 25bp over the coming weeks.

EUR/USD looks to have stalled at the top of a potential 1.02-1.08 trading range this summer and we could quite easily see a near-term move back towards the 1.0500/1.0550 area as the Fed cycle is repriced higher. We struggle to see the ECB 'out-Fedding' the Fed when it comes to tightening - even though the ECB seems to be using the prospect of aggressive tightening to support EUR/USD. Two-year German-US spreads have narrowed into 215bp from a wide of 254bp in April, but this narrowing may have come far enough for the time being.

Elsewhere in Europe, the Hungarian forint is under pressure as the new Orban government announces a state of emergency to enact new policies. Addressing twin deficits is a key priority for the Orban government. How the government chooses to address the budget deficit - e.g. what kind of taxation - looks to be posing challenges for the forint. There is outside risk that EUR/HUF trades back to 400 again and that the National Bank of Hungary has to respond with even higher rates.

The focus in the UK today is on the potential announcement from Chancellor Rishi Sunak (at 1230CET) of a £10bn fiscal stimulus to address the cost of living crisis. This could be a means-targeted measure coming through energy bills. What could this mean for sterling? The positive could be that it allows the Bank of England (BoE) more freedom to hike. The market currently prices the BoE bank rate at 2.13% for December (which is already quite high). The negative could come through the equity channel where the windfall tax on oil, gas and electricity suppliers could deliver UK equity underperformance.

We prefer the former factor dominating and EUR/GBP trading back towards the lower end of a new 0.8450-0.8600 trading range.

The Central Bank of Russia (CBR) has announced an emergency monetary policy meeting for today. There is widespread speculation that a large rate cut is coming in response to the stronger rouble. Recall that the emergency rate hike to 20% in February was designed to support the rouble and protect banks from an outflow of rouble deposits. In fact, the capital controls introduced by Russia and the powerful current account surplus (US$96bn year-to-April) have generated a much stronger rouble - and one that hits expected government revenues and the fiscal position.

This week has already seen Russian authorities try to address the strong rouble by softening domestic capital controls. Russian exporters are now required to sell 50%, instead of the prior 80%, of FX export earnings within a 60-day period. Our Russian economist, Dmitry Dolgin, is looking for a 200-300bp CBR rate cut today to take the base rate to 11-12%. This large cut should be aided by signs that inflation expectations are falling and in an effort to soften what Dmitry thinks will be a 10-15% fall in Russian GDP this year.

As to the rouble, Dmitry thinks USD/RUB will be ending the year around 75 as the partial or potential total EU embargo on Russian oil hits in 2H22, while at the same time Russian resident demand for FX and imports start to stabilise. Before then, however, and because USD/RUB is mainly being driven by Russian commercial flows, a large rate cut may not send the rouble too much lower in the near term.