FX Daily: Terms Of Trade Back In Focus

(MENAFN- ING) USD: All systems are go

We see three factors that can keep the dollar strong near term and probably send it a little stronger. The first is the ongoing energy shock primarily being felt through natural gas prices. These prices continue to rise as importers compete for cargoes ahead of the northern hemisphere winter and the very uncertain supply situation. In financial markets, the cost of higher gas prices is born out in terms of trade indices. Energy importers such as Europe and large parts of Asia are seeing their terms of trade indices (export versus import prices) continuing to dive. These effectively represent a large negative income shock. The energy independence of the US leaves the dollar relatively insulated on this score.

The second factor is the one we highlighted yesterday – the uncertainty as to whether the People's Bank of China (PBoC) will engineer another mini-devaluation in the renminbi as it searches for growth. The PBoC overnight fixed USD/CNY in line with model-based estimates. This is being read rather equivocally by markets as the PBoC is not actively encouraging speculation of a weaker renminbi, nor delivering a stern warning against yesterday's renminbi sell-off. USD/CNH is now trading through 6.80 and a move through 6.82/84 will certainly raise speculation of something larger afoot akin to the April/May 6% renminbi devaluation. That period saw the DXY dollar index up around 6% too.

The final factor is the US economy and the Fed story. Today sees the release of July industrial production and tomorrow the release of retail sales. Our team sees better figures for both – largely helped by lower gasoline prices. The figures should temporarily allay US recession fears and prepare the markets for what could be a hawkish set of FOMC minutes tomorrow night. We agree with Padhraic Garvey's opinion piece that the Fed probably wants tighter financial conditions now – which implicitly include a firmer dollar.

In all, we continue to prefer north American currencies, where last week we picked out the Mexican peso for some carry . The Canadian dollar also should remain supported on dips and today sees some July CPI data. This can shed light on whether the Bank of Canada hikes 50bp or 75bp on 7 September (59bp currently priced). Of the three, we would probably prefer slightly overweight US dollar positions since the risk environment could easily deteriorate again.

106.95/107.00 looks like the near-term target for DXY.

In addition, please find the August edition of FX talking here and also some thoughts on where ESG issues interact with the FX market . 

Chris Turner

As Carsten Brzeski noted yesterday , Germany continues to suffer both with low water levels on the Rhine and now a gas levy for German consumers. The gas levy could keep German inflation higher for longer and cause more headaches for the European Central Bank (ECB). The trade-weighted euro is a whisker away from the lows of the year and a slightly stronger dollar over the next 48 hours could easily see EUR/USD retesting parity. 1.0200 should now prove short-term resistance.

In terms of data today, look out for German and eurozone investor expectations for August. These should remain near the lows despite a decent last month for European equities.

Chris Turner

News that Germany will impose a gas levy – confirming that the government cannot fully shield households from the spike in gas prices – leaves the UK less of an outlier in Europe. This will be one of the factors helping to limit EUR/GBP gains and could actually favour a drift back to the 0.8390/8400 area. Today's July UK employment data is somewhat of a mixed bag for sterling. This showed a slight slowing in hiring but strong average earnings – the latter pointing to hoarding of staff. We think the data supports a 50bp Bank of England hike on 15 September (45bp currently priced). In all, EUR/GBP can soften a little, but a stronger dollar means that Cable can go sub 1.20 again.

Chris Turner

The strong US dollar quickly took back almost all of the CEE region's recent currency gains. However, the invisible hand of the market intervened in a different order than we had anticipated yesterday. While the Polish zloty lost the least and narrowly avoided 4.700 EUR/PLN, the Hungarian forint came under heavy sell-off, hit by the rating outlook downgrade from S&P. And the koruna returned halfway to CNB's intervention levels. In all three cases, we can expect more losses today, in our view.

The regional calendar is almost empty and global conditions for CEE currencies have deteriorated again, led by a stronger US dollar. We continue to believe the zloty should head above 4.700 EUR/PLN, while the forint has lost too much in our view. It can be expected to remain out of the market's favour for some time due to the rating decision, but market conditions remain most favourable for the forint. This is the only currency in the region that can rely on a rising interest rate differential. Once the jitters over the rating outlook change subside, the forint could return to 396 EUR/HUF.

Frantisek Taborsky

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