FX Daily: Bumpy De-Escalation

(MENAFN- ING) USD: Fed story providing support

With cash and futures equity markets powering ahead on Monday's de-escalation trade, one might have expected to see the dollar weaker across the board – but it has been holding up quite well. We suspect this is being driven by the view that the Federal Reserve is about to turn less dovish at a time when softer activity data is raising questions over how aggressive other central banks, especially in Europe, can be with their tightening this year.

The Fed's newfound position was nicely encapsulated in a speech by Christopher Waller last Friday entitled: 'Policy Risks Have Changed '. The market briefly priced one full 25bp Fed hike last Friday on his comments that the longer oil prices stay this high, the greater the risk of inflation expectations becoming unanchored and the Fed needing to hike. That briefly triggered some bearish flattening of the US yield curve – a clear dollar positive.

Looking ahead this week, the question is whether the dollar needs to sell off much if there is concrete news of de-escalation in the Middle East. We suspect the answer is 'not much', with financial markets now more interested in the economic fallout on activity and inflation. For the US this week, the focus will be on whether the weekly ADP jobs numbers can stay strong (a cycle high at +42k was seen last week) and on the rate of inflation in April. Thursday sees the release of the PCE price data, where Waller estimates headline inflation will have risen to 3.8% year-on-year from 3.5% and core to 3.3% from 3.2%. Any upside surprises here would firm up the pricing of a Fed hike this year and help the dollar. There is a whole host of Fed speakers scheduled this week, too.

If the dollar remains steady to slightly stronger this week, it could give room for more local stories to shine through. Here, we think tomorrow's Reserve Bank of New Zealand meeting could be a little more hawkish than expected, which could lend some support to the New Zealand dollar.

For the DXY, we expect it to remain supported in a 99.00-99.50 range, with Thursday's PCE inflation data presenting the biggest risk of a range breakout.

Chris Turner

EUR: Whatever happened to three ECB rate hikes?

Having priced over 80bp of tightening from the European Central Bank this year, markets are now pricing just 55bp. A lot of that adjustment looks like short-term interest rates slavishly following oil prices. Yet last week's batch of softer European PMI data clearly warns of a contraction in European activity in the second quarter. The ECB is undoubtedly breathing a sigh of relief over market pricing of rate hikes, and we think it will hike only once this year, in June.

We have been saying for some time that we think EUR/USD fair value at the moment is around the 1.16/17 area and that there is not a strong case for a breakdown to 1.1500. Yet that may be the direction of travel should more members of the FOMC speculate about a rate hike, and as the European data continues to disappoint.

In terms of data this week, we'll get our first look at some of the eurozone May inflation data at a country level and a final look at the first-quarter GDP readings. On the face of it, there is nothing clearly on the calendar to drive big market moves, and the offered tone in EUR/USD implied volatility looks set to continue. Expect ongoing interest to play the downside in cross rates like EUR/AUD, where the Australian dollar's high carry and perhaps another hot Australian inflation release tomorrow (April data) could firm up expectations of even more Reserve Bank of Australia rate hikes this year.

Chris Turner

HUF: NBH getting closer to rate cuts

The main event this week in the CEE region is today's meeting of the National Bank of Hungary. Our economists expect rates to remain unchanged at 6.25%, which is the consensus call, but market pricing sees a small chance of a rate cut with the rapidly falling BUBOR below the policy rate. In recent weeks, the NBH has emphasised the June forecast as the basis for further decisions. Therefore, we see it as premature to expect a rate cut today, and it seems that the risk is rather on the hawkish side if the NBH were to question the June rate cut.

Still, the market is pricing in around 5.60% rate for the end of the year, assuming the BUBOR spread remains negative, which is not too excessive given the strong market conviction regarding the June cut. In turn, we believe that while June pricing may see some hawkish pushback as a risk, market pricing suggests scope for some further movement lower at the front end, alongside possible spread compression.

EUR/HUF bounced back from 362 in the second half of last week and is now back below 357. Global relief last week and over the weekend, alongside comments from the NBH regarding euro adoption, helped the forint to gain again. We maintain EUR/HUF 350 as our mid-year target, but trading in recent weeks suggests that heavy long positioning may limit the scope for a further HUF rally, and the market appears to be shifting towards bonds and rates, especially if the NBH starts cutting rates.

Frantisek Taborsky

CEE: Time to reduce market hawkish pricing

Yesterday's retail sales data in Poland surprised with a slight decline in April compared to the previous month, still posting a year-on-year increase. Consumer confidence in the Czech Republic fell more than expected in May. Both together indicate some slowdown in the region's economy in the second quarter, which may reflect uncertainty stemming from the conflict in the Middle East.

The rest of the week's calendar in the region is rather light, and apart from today's NBH meeting, Friday's Polish inflation figures will be the highlight. We expect another increase in May from 3.2% to 3.7% YoY, the highest within the CEE3 and the highest since June last year. At the same time, it will be the first time since June that inflation has risen above the National Bank of Poland's tolerance band.

On Friday after trading, S&P will publish a country rating review of Hungary, where it holds BBB- with a negative outlook. It is probably too early to see an improvement in the outlook. The agency's comments may provide a new perspective following the general election, especially in the context of the current negotiations on access to EU funds, where Prime Minister Péter Magyar expects to sign a deal on Thursday this week.

The global story should once again be the main driver this week, and after the headlines on the US-Iran talks, we should see a positive opening already indicated by yesterday's semi-open markets in the region. While the relationship between front-end rates and oil prices has somehow broken down in recent days, oil below $100 implies a roughly 20-30bp rally in 1y1y PLN and CZK rates with FX protected, given yesterday's rally in EUR rates.

Frantisek Taborsky

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