FX Daily: Dollar To Weigh Up Warsh

(MENAFN- ING) USD: Warsh to steepen the yield curve

Investors continue to take a bullish view of events. Although not confirmed, Iranian negotiators are expected to travel to Pakistan to engage in peace talks with the US later today or early tomorrow. As is his way, President Trump continues to threaten a binary outcome – deal or destruction – after tomorrow's ceasefire expires. For the time being, the market seems happy to sit pro-risk on the view that the ceasefire will at least be extended. Also buoying equities has been the shift back to the tech story. Positive news came out of Asia overnight with EQT AB raising $16bn, the largest pool ever, for a private equity Asia fund, and semiconductor exports from Korea maintaining heady export growth rates at 50% YoY.

Amid this pro-risk, soft dollar backdrop, Kevin Warsh appears in front of the Senate at 1600CET today. My colleagues James Knightley and Padhraic Garvey preview that hearing here. The consensus view in markets is that Warsh will be dovish on the policy rate and hawkish on the Fed's balance sheet. The balance sheet discussion could get a bit technical in the form of the choice of reduction (roll-offs or active sales), which securities (Treasuries or Mortgage Backed Securities) and whether the resulting decline in surplus liquidity could trigger another 2019-like crisis in the repo market. Investors expect a steeper curve from all this.

Barring comments on the Fed's balance sheet that unnerve the long-end of the Treasury and risk assets, Warsh's comments on the policy rate will probably be a bigger driver of the dollar. With oil prices and short-term inflation expectations high at the moment, comments which see short-dated swap rates and real rates come lower will be dollar negative. We doubt moves will be large, however, because unless the Department of Justice drops its investigation into the Fed's reconstruction project, Republican Senator Thom Tillis will still prevent the Warsh nomination from proceeding to a full vote in the Senate.

Away from politics, the US data calendar sees the release of the March retail sales numbers and the ADP weekly employment release. If the Fed's Beige Book is to be believed, neither retail sales nor employment fell off a cliff in March – but any surprise weakness would add to the dollar's downside.

DXY could drift towards the 97.50/60 area on today's agenda.

Chris Turner

EUR: Foreigners like eurozone assets

Last week's Balance of Payments figures released by the ECB showed continued strong foreign buying of eurozone asset markets in February. Combining both purchases of equities and debt, foreigners had already bought EUR280bn of eurozone assets in the first two months of this year. So while US TIC data does not show any outright sales of US long-term assets, the strong demand for eurozone assets suggests that, at the margin, the euro could be benefiting from new funds being put to work.

On the calendar today is the German ZEW investor survey and a variety of ECB speakers this morning. ECB President Christine Lagarde has made the ECB's position pretty clear. However, more data is required. The market now sees very little chance of an ECB hike later this month but a 68% chance of a hike in June. We expect the ECB to deliver a June hike to impress its inflation-fighting credibility on markets.

EUR/USD is trading in a tight 1.1750-1.1800 range, but could move to 1.1850 if Kevin Warsh says something dovish.

Chris Turner

GBP: Shaking off local politics so far

Despite UK Gilts underperforming yesterday – presumably on the view that there may be a change in the Labour leadership – sterling has held up reasonably well. Today's big drop in the February unemployment rate probably overstates the health of the UK labour market – inactivity rose, so sterling does not need to trade a lot stronger on this.

Today's focus will be on the morning testimony from the top civil servant who was sacked over failing to disclose the results of the Mandelson vetting process. However, the Polymarket betting site only gives a 39% probability of PM Starmer leaving office by June (65% by December) and is perhaps one reason why sterling is not selling off more.

Expect EUR/GBP to find ongoing support in the 0.8685/8700 area.

Chris Turner

ILS: The shekel is incredibly strong

The Israeli shekel has been one of the strongest performing currencies since the start of the crisis – appreciating 5% against the dollar. What is driving that strength remains unclear, although Israeli tech capital raising has often been blamed for that strength in the past. Historically, the Bank of Israel has been one of the most interventionist central banks out there and had intervened heavily to prevent a much stronger shekel. Yet the White House's focus on currency manipulation may have discouraged the BoI's FX intervention activity this year.

However, the shekel is now incredibly strong. The trade-weighted, inflation-adjusted shekel is at an all-time high. If the BoI cannot intervene in FX, then rate cuts can take the pressure off the shekel. That is why the market now prices 100bp of BoI easing over the next six months. But bottom line, we doubt the BoI will tolerate sustained shekel gains from here, and we forecast USD/ILS to head back to the 3.00-3.20 area later this year.

Chris Turner

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