FX Daily: Waiting for the central bank response

The weekend brought little respite to the war in the Middle East. US and Israeli militaries continue to pound strategic targets in Iran, while Iran continues its strategy of spreading economic chaos in the region and keeping the Strait of Hormuz effectively closed. The latest initiative from Washington is to try to assemble a naval coalition to escort convoys through the Straits. The Financial Times suggests that China, France, Japan, South Korea and the UK have been asked. It is unclear whether any would accept. This news failed to impress the energy market, where Brent remains near its highs and could go higher the longer Middle-East oil supply remains shut-in. It looks like the market wants to hear news on a path to a ceasefire before removing the risk premium buoying energy and the dollar.

But until there is some news of a negotiated settlement, the market this week will be focusing on the central bank response. Eight of the G10 central banks meet to set monetary policy this week. Of those, the closest to hiking will probably be the Reserve Bank of Australia, where a 25bp hike is about 70% priced. However, our Asian team thinks it may be too early for another hike, meaning that AUD/USD faces some downside risk in Asia tomorrow.

Regarding this week's FOMC meeting, we think the event risk is dollar positive. At the January FOMC meeting, the takeaway was that the Federal Reserve wanted to see clear signs of lower inflation before delivering further rate cuts. Events in the Middle East warn that US inflation will be heading to 3.5% and not 2.0% this summer. The FOMC will likely further question market pricing of another Fed rate cut this year, where around 23bp is still priced in by year-end. And the Fed's dot plot could also shift the median expectation of one cut this year back into 2027 as well.

DXY is now at the top of the nine-month trading range at 100.35/40. A calmer equity environment this Monday morning suggests DXY may not be ready to break higher just yet. But investors will want to see clear evidence of improvement in the conflict before trying to pick a top in the dollar.

Chris Turner

The latest positioning data from the CFTC in Chicago shows that investors continue to pare back euro net long positions. Yet looking at the asset manager community, positioning remains heavily net long euro and there are more adjustments to be made should conditions dictate.

Thursday's European Central Bank meeting could also prove mildly hawkish. But the difference to the Fed is that the market already prices close to 50bp of ECB rate hikes this year. In turn, the bar is high for the ECB to move short-dated euro interest rates and the euro higher.

EUR/USD has found support at last summer's low near 1.1390/1400. Some consolidation may be due after a quick 3% drop over the last fortnight. We do think that EUR/USD will start to move higher over coming months once oil supplies start to flow again. But that still seems a distant prospect today and another leg higher in energy could see EUR/USD still extend to the 1.12/13 area given the overhang of net euro long positioning.

Chris Turner

The Swiss National Bank meets on Thursday. The strong Swiss franc will be a major concern, and the central bank will probably describe it as 'highly valued' and confirm that it is increasingly minded to intervene in FX markets. The SNB could also try to lower interest rates through an adjustment in its remuneration of CHF sight deposits. Last September, the SNB cut the exemption on the 25bp charge on excess sight deposits to 16.5 versus 18 times minimum required reserves.

We would see upside risk to EUR/CHF around the Thursday event risk. But unless the situation alters substantially in the Gulf, it looks like the SNB will be drawn into a long campaign to support EUR/CHF below 0.90.

Chris Turner

Global headlines indicate little improvement in sentiment compared to last week, and the CEE region can be expected to remain under pressure this week.

The CEE calendar has little to offer in the second half of the month. Today, core inflation in Poland for February will be published, which, according to our expectations, fell slightly from 2.7% to 2.6%. In the Czech Republic, February PPI numbers will be published.

On Thursday, we will see labour market and industrial production numbers for February in Poland. However, the main focus will be on the meeting of the Czech National Bank, where rates are expected to be left at 3.50%. The decision itself should not be too dramatic, and more attention will be to forward guidance. Part of the bank board has already signalled in previous days that rate hikes are not on the table in response to higher energy prices and that it would like to return to the discussion of rate cuts if the situation calms down in the near future.

Weekend headlines and early opening suggest that risk-off sentiment will persist in the CEE region this week, and a further sell-off in rates and FX can be expected under pressure from rising oil prices. We expect Hungary to remain the most exposed country for the market, and EUR/HUF will continue to be a good indicator of tensions in the region. The 2y HUF IRS has jumped by more than 120bp in the last two weeks and leads the EM space. While the market is pricing in rate hikes in the coming months and a return to the near-7.00% National Bank of Hungary rate, we believe that the NBH will leave rates unchanged unless it sees a significant increase in inflation above the tolerance band, or if EUR/HUF continues well above 400 – which, for now, seems to be a high bar.

Frantisek Taborsky