FX Talking: Dancing in the dark

In the absence of forward guidance from the Federal Reserve, the dollar is holding onto gains made over the last eight weeks. These gains were largely driven by the June FOMC meeting when the central bank gave the impression that it was prepared to tighten rates to restore policy credibility. ING’s house call, however, is that the Fed will ultimately look through this temporary rise in inflation and avoid tightening. This suggests that dollar gains won’t last.

Barring a major escalation in the Gulf conflict, our Fed call means that EUR/USD should continue to meet good demand near the 1.13 area and should end the year near 1.17/18 once short-dated US rates start to drop again. Cheaper dollar hedging costs and some uncertainty around US midterm elections could also weigh on the dollar. In the eurozone, a September hike from the European Central Bank and a supportive equity market could help the euro.

Across the G10, we expect activity currencies backed by hawkish central banks to perform well. Here, we highlight the Australian dollar and the Norwegian krone, while a dovish central bank and looming USMCA renegotiations should see the Canadian dollar lag. Equally, the low-yielding defensive currencies of the Japanese yen and Swiss franc should continue to underperform in what is still a pro-risk, low-volatility investment environment.

In EM, the surprise dovishness of the National Bank of Poland has weighed on the zloty. In any case, we had been favouring the Czech koruna and Hungarian forint over the zloty, and still do. Ongoing interest in carry trade strategies should keep South Africa’s rand and much of Latam FX supported this summer. And in Asia, it is hard to see a major advance in local currencies until interest rates are hiked substantially.