FX Talking: Some stark divergence

Nearly eighteen months after the emergence of the Covid-19 pandemic, the world’s economies are still trying to break free from its grasp. Generally, those nations with strong vaccination records have been better able to withstand renewed waves of the virus. Central banks in those countries have maintained growth forecasts and tick off objectives on their path to monetary normalisation. The Federal Reserve falls into this camp.

We expect the Fed to discuss tapering bond purchase at the Jackson Hole symposium later this month, firming up expectations that the central bank will start tightening in early 2023 or even late 2022. Our preference is that the dollar enjoys a more powerful rally six months before the first tightening - that’s 2Q22. Before then, an orderly tapering cycle and weak seasonality present a more neutral dollar environment into year-end.

Such an environment allows some stark divergence to play out.

Here a very dovish ECB will keep EUR/USD vulnerable towards the bottom of a 1.17-1.23 range. But the start of tightening cycles in New Zealand and Norway should see some FX out-performance, as now could UK after the August Bank of England meeting. We’re also generally bullish on CEE FX with tightening cycles underway or about to start in the Czech Republic, Hungary and Poland.

Elsewhere in emerging markets, we are bullish on those currencies backed by aggressive tightening cycles (Brazil and Russia) and Mexican FX on the remittance story. But the elephant in the room is Renminbi. The Delta variant spread in China and Asia could drag the People's Bank of China into more sustained easing.

The speed with which USD/CNY trades above 6.50 bears watching and looks set to cast a shadow over Asian FX as a whole.