FX Talking: How low can you go?

Given fears of a global recession, ‘How low can you go?’ is now a pressing question being asked of many risk assets and of key FX pairs like EUR/USD. Investors hold out little hope for improvement in energy supplies anytime soon and central bankers are showing no signs of being distracted from forceful monetary tightening cycles. That all points to equity markets perhaps another 10% lower and a worst case for EUR/USD near 0.95.

The ECB in particular faces the conundrum of trying to address inflation fears, while at the same time trying to avoid driving the Eurozone economy into recession. While it may only deliver 100bp of the 175bp tightening currently priced by the market, our team now look for a Eurozone technical recession in 4Q22/1Q23. This will weigh on pro-cyclical currencies like the euro, sterling, the Swedish krona, and many currencies in CEE.

Outperformers in what will be a difficult summer for risk will likely remain the dollar, the yen and the Swiss franc. In fact, the Swiss National Bank is now using its huge war chest of FX reserves to ensure the franc does just that – strengthen.

Peak pain this summer and the focus on demand destruction will keep commodity currencies on the back foot. Most vulnerable may well be the likes of the South African rand and the Brazilian real – the latter shaping up for contentious elections in October.

And in Asia, high beta currencies like the Korean won will remain soft as will the Philippine peso and Indonesian rupiah, the latter pair left vulnerable by dovish central banks. USD/CNY set to remain range-bound while Covid policy and geopolitics dominate.