FX Talking: Go hard or go home

Go Hard or Go Home’ is the message the FX market is delivering to central bankers trying to protect their currencies in the face of an energy price shock. In practise this means that unless central bankers deliver aggressive monetary tightening to somehow insulate against a Fed policy rate at 3%, local currencies will continue to lose ground. Here, policymakers in the eurozone and particularly Japan remain on a very different page to the Fed.

This argues for further dollar strength against EUR and JPY. Additionally, the legacy of the war in Ukraine is a stagflationary one – especially for Europe. We think the negative terms of trade shock has damaged the medium-term fair value of the Euro and we can see EUR/USD starting to carve out a 1.05-1.10 range through the summer as the Fed front-loads its policy adjustment. We think it too early to be asking when the dollar will peak, but in short, we would favour dollar strength for most of this year and perhaps only a decisive turn lower starting in summer 2023.

Elsewhere, the lasting strength of commodity prices will continue to favour the commodity exporters in the energy, metals and softs arenas. In general, this is good news for the currencies of American energy exporters and Latam, while negative for Europe and large parts of Asia. Asia in particular will suffer both from wider energy deficits and also the relatively large weightings to food and energy in local CPI baskets.

And finally, monetary tightening in CE4 has been impressive. Were a path to peace to be found in Ukraine, some currencies in the region could rally further. The Polish Zloty is the standout here, where external transfers could now be converted in the spot market.