FX Trends: USD: Overheating?

We believe the USD will struggle to extend its month-long rally over the coming weeks, given the already sizeable move higher in US yields. At Jackson Hole, the Federal Reserve (Fed) Chair Powell neither built rate hike expectations in September, nor offered signs that the long-run interest rate was about to be reset much higher. All this suggests the Fed is content to hit the pause button, and we suspect the USD rally might hit pause as well. The USD is vulnerable to any dovish signals, notably around US CPI for August (13 September). That said, a material USD reversal weaker will need hawkish developments outside of the US.

After a tough month for EUR-USD, we think risks are tilted for EUR-USD upside. The coming weeks could become more fixated on the likely outcome of the respective upcoming meetings of the European Central Bank (ECB) (14 September) and the Fed (20 September). Our economists expect the ECB to hike by 25bp and for the Fed to leave policy unchanged. With only 8bp of tightening priced in for the ECB (Bloomberg, 29 August 2023), a September hike could have a significant positive impact on the EUR. On that front, the Eurozone CPI release (31 August) is likely to be the key determinant of whether a hike is delivered. Our economists forecast the core CPI rate to remain at 5.5% YoY in August, as services inflation remains sticky.

GBP-USD may find a base at current levels and we think a 1.25-1.30 range may now take hold over the coming weeks. The key for the GBP in the near term, assuming the case for a 25bp hike remains in place, is whether the data in the run-up to the Bank of England (BoE) meeting on 21 September will foster guidance that more tightening is likely, or that a pause might be warranted. There are a few key crunch points that should determine this in the coming weeks, including labour market data on 12 September, July activity data on 13 September, and August CPI on 20 September. Our economists expect a fresh acceleration in the headline CPI rate to 7.1% YoY in August from 6.8% in July, with the core reading at a still lofty 6.9% YoY.

We expect USD-JPY to track sideways over the near term, caught between the forces of US yields, risk appetite and possible FX intervention. USD-JPY is mostly determined by its yield differentials. Japan’s Ministry of Finance (MoF) FX intervention could become a focus again, if USD-JPY were to rise alongside further weakness in US Treasury markets. However, if US yields stabilise, then risk appetite might get more traction and help stabilise the JPY in turn.

We expect USD-CHF to grind lower over the coming weeks. Domestically, a 25bp hike by the Swiss National Bank at its 21 September meeting, coupled with hawkish guidance, will likely be CHF-supportive. Markets currently price in a 39% chance of a 25bp hike (Bloomberg, 29 August 2023). However, we suspect external market developments, with a likely decline in the DXY or a possible rebound in EUR-USD, will be the bigger consideration for the CHF over the near term.

Our analysis suggests that the rally in USD-CAD looks overdone, relative to US-Canada yield differentials or risk sentiment. Oil prices do not offer the explanation either (e.g. the CAD failed to capitalise on the July oil rally.) While our central case is for the Bank of Canada’s (BoC) inaction at its 6 September meeting, the accompanying rhetoric will likely be hawkish (given sticky inflation and higher wage growth), which could trigger a reversal in the currency pair in the weeks ahead.

The AUD has faced both external and domestic headwinds lately. However, our short-term valuation metrics suggest pessimism is in the price, with difficulty for AUD-USD to break below 0.64 decisively. Therefore, we expect the currency pair to stabilise in the near term, even though risks are skewed towards further downside. Markets expect the Reserve Bank of Australia (RBA) to pause at its 5 September meeting (Bloomberg, 29 August 2023).

The NZD’s trajectory has been quite similar to that of the AUD, with similar headwinds, such as weak terms of trade and a less hawkish central bank. However, the NZD faces an additional headwind in the form of an asymmetrical sensitivity to risk appetite, given New Zealand’s historically wide current account deficit, which is prone to a stall of external funding.

Note: *as at 11:50 HKT on 30 August 2023

Source: HSBC, Bloomberg

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Dovish

Dovish refers to an economic outlook which generally supports low interest rates as a means of encouraging growth within the economy.

Hawkish

Hawkish is typically used to describe monetary policy which favours higher interest rates, and tighter monetary controls to keep inflation in check.

MoM / YoY

Month on month / Year on year

PMI

Purchasing Managers Index (PMI) is an indicator of economic health of the manufacturing sector (>50 represents expansion vs. the previous month).

IMM data

International Monetary Market (IMM) is a division of the Chicago Mercantile Exchange (CME) that deals with the trading of currencies and interest rate futures and options and the IMM data is part of the Commitments of Traders (COT) reports published by the U.S. Commodity Futures Trading Commission (CFTC). The IMM data provides a breakdown of each Tuesday’s open futures positions on the IMM. Speculative positions are a trader’s non-commercial positions (i.e. not for hedging purposes).

G10

G10 refers to the most heavily traded, liquid currencies in the world: USD, EUR, JPY, GBP, CHF, AUD, NZD, CAD, NOK, and SEK.

Fed / FOMC

Federal Reserve System (US’s Central Bank)/Federal Open Market Committee.

ECB

European Central Bank (Eurozone’sCentral Bank).

BOE

Bank of England (UK’s Central Bank).

BOJ

Bank of Japan (Japan’s Central Bank).

BOC

Bank of Canada (Canada’s Central Bank).

RBA

Reserve Bank of Australia (Australia’s Central Bank).

RBNZ

Reserve Bank of New Zealand (New Zealand’s Central Bank).

SNB

Swiss National Bank (Switzerland’s Central Bank).

Lagarde

Christine Lagarde, President of the European Central Bank (ECB).

Powell

Jerome Powell, Chair of the Board of Governors of the Federal Reserve System (Fed).

Bailey

Andrew Bailey, Governor of the Bank of England (BOE).

Kuroda

Haruhiko Kuroda, Governor of the Bank of Japan (BOJ).