FX Talking: Dovish Fed, calm seas – what could go wrong?

A soft August nonfarm payroll report and a dovish Jackson Hole speech from Fed Chair Jerome Powell have taken some of the sting out of the dollar’s upside. Heading into the autumn, expected FX volatility is falling and FX players are backing those currencies where local central bankers feel confident enough to tighten policy. We expect this theme to run further.

Even the unloved EUR has found a few friends over recent weeks as hawks on the European Central Bank demand a reassessment of pandemic support levels. We doubt this independent EUR strength has a lot further to run. But equally a Fed happy to go slow with the taper – and break the link between tapering and tightening – means the dollar can tread water. This will allow EUR/USD to trade out a 1.17-1.20 into year-end and focus to remain elsewhere.

What could go wrong? Asia has been the weak link in financial markets this year and with the People's Bank of China looking set to ease policy further, a USD/CNY move through 6.50 could upset some bullish bets in emerging market currencies. Equally, the credit market is intrigued about the default chances of Chinese real estate developer, Evergrande, and any contagion.

But for the time being, low volatility and still abundant liquidity mean that high yielding FX is still in favour. And given that it does not take a lot to be a high yielder in Europe, further tightening should keep the Hungarian forint and Czech koruna in demand. Sterling has enjoyed a slightly more hawkish Bank of England, yet the (small) hiking cycle looks fully priced and tension with Brussels end September should limit sterling strength.

In all, we continue to favour a pro-risk stance in FX even though September is normally a sticky month for US equity markets.