FX Talking: Has the Fed overcooked the tightening cycle?
FX markets have seen a volatile summer as fears have grown over a sharper US slowdown. Has the Federal Reserve kept rates too high for too long? We continue to look for a soft landing in the US and weak recoveries in Europe and Asia. For FX markets, this should mean a shift to some orderly dollar weakness from the disorderly position adjustment of recent weeks
Should equities settle a little, we expect to see EUR/USD re-connect with rate spreads and drift towards the 1.12 area before an expected 50bp Fed rate cut in September. For USD/JPY, the speculative market is now much better balanced than it was at the start of July. A more macro-driven environment favours targets in the 137/140 area.
Elsewhere in the G10, some calmer conditions should allow the badly hit Australian dollar and Norwegian krone to enjoy a strong recovery into September. We expect sterling to lag as it becomes clear the Bank of England is embarking on a decent easing cycle. And the Swiss franc should outperform as global interest rates move nearer to those in Switzerland.
Within EMEA, we prefer the Polish zloty, where the market under-prices the risk of a hawkish central bank. The Hungarian forint remains vulnerable, while the Czech koruna is showing more signs of stability. Amongst the high yielders, both the Turkish lira and the South African rand should outperform their forward curves.
Latam FX is less compelling than it was. We are still concerned over fiscal risks in Brazil, local politics in Mexico, and copper prices in Chile. Asian FX could start to perform a little better on the softer dollar story – but weak China growth remains a drag on the region.
