FX Daily: Hawkish drift

(MENAFN- ING) The central banks of Brazil and Canada are the latest to be caught in the hawkish policy drift, while pressure is building on Australia's RBA too. A lot of this has already been priced, meaning that FX rates have not moved too much. Today the main focus will be on the ECB, German inflation, and quantification of the 3Q dip in US growth.

• USD: 3Q dip in US GDP should be old news
• EUR: ECB to resist the hawkish pressure
• GBP: Rishi reserve
• BRL: BACEN does its thing

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FX markets continued in their relatively narrow ranges overnight. The heavily-backed commodities currencies complex has softened a little on the back of lower energy and raw material prices - energy hit by Iranian nuclear talks , higher crude inventories and Putin's instruction to Gazprom to fill up European storage starting November 8th.

The big story continues to be, however, the hawkish drift in global central bank policy (ex Japan and most likely ex Eurozone later today). The BoC surprised yesterday by curtailing QE earl y, while Brazil's BACEN shifted to 150bp tightening increments (more on that below). This question is whether the Fed needs to turn more hawkish too and whether the market can shift to fully pricing three Fed hikes in 2022?

More hawkish pricing of the Fed may not be the story today in that we will see US 3Q21 GDP data. Consensus sees a drop in the QoQ annualised rate to 2.6% in 3Q from 6.7% prior. Our US economist, James Knightley, broadly sees a similar number to consensus, although does not rule out a much weaker number. Yet we are confident of the 4Q21 US rebound - the consumer and businesses are in good shape - such that any dollar weakness on the GDP data should find good buying interest. 

DXY has not done too much this week, but we would expect 93.50 support to continue to hold any intra-day weakness. And a high US PCE deflator figure tomorrow could set US rates and the dollar back on a rising trend.  

As we discuss in our ECB cribsheet , we think Christine Lagarde will try to avoid giving too much/anything away about future policy deliberations at the December 16th ECB meeting. Most in the market probably expect some kind of pushback against the market pricing of 2022 ECB tightening, where a 10bp rate hike is now priced for next September. This all seems a little obvious and perhaps a reason for EUR/USD not to sell-off were Lagarde to deliver. Yet our short term Financial Fair Value models suggest EUR/USD is some 2% over-priced (it should have fallen on the recent run-up in short-dated US yields), so we continue to see EUR/USD downside risks here.

We favour EUR/.USD exiting the shallow 1.1585-1.1625 range to the downside in a move to the 1.1525 area.

Elsewhere, another of the ultra-dovish central banks, Sweden, may see its policy questioned. Currently, it plans to keep the repo rate at zero until 2024. Today Sweden sees the Economic Tendency Survey and 3Q GDP data. We also see a speech from arch-hawk Ohlsson at 10CET. EUR/SEK is now trading comfortably below 10.00 and any upside surprises in activity or inflation expectations in the survey could raise expectations of a less dovish stance at the Nov 25th Riksbank meeting. Favour EUR/SEK to stay offered.

GBP was slightly weaker on the day yesterday. It is always hard to get an overall picture on the budget, but the big story seemed to be better growth forecasts and lower borrowing forecasts - which triggered a big rally in Gilts on the prospect of reduced supply. So the drop in Gilts yields should not be confused with meaning more dovish BoE pricing. In fact, the takeaway from the budget seemed to be the view that the chancellor, Rishi Sunak, was saving a pot of money to be given away in tax cuts ahead of the next UK election which we could see in late 23/24. If anything this could prompt a slight revision higher in the BoE tightening profile.

EUR/GBP looks to be trading a 0.8420 to 0.8470 range. GBP should stay bid into next week's BoE rate meeting. We are a little worried about politics though. After COP26, the UK may actually want to trigger Article 16 to reset the N. Ireland protocol - inserting some political risk premium back into the pound. 0.8400 looks probably a solid near term floor.

BACEN increased the pace of its tightening cycle to 150bp last night. This was prompted not only by faster inflation - now running above 10% - but fiscal risk premia which are driving the BRL weaker. Here the government, voted in on a ticket of fiscal consolidation, is looking at breaking fiscal rules - this in advance of Presidential elections to be held in November next year.

It is interesting to see the divergence now emerging in the Brazil versus Mexico sovereign CDS. Brazil spent big during the pandemic, Mexico spent far less and Brazil's spending could be exposed in an environment of higher DM rates and a forthcoming election.  

Because of this divergence, expect BRL/MXN to continue in its long term bear trend to levels below 3.50.

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