FX Daily: Relentless energy rises re-price terminal rates and FX |

What seemed like a compelling theme last week to explain FX market price action lost some support yesterday. Last week’s dollar weakness was being ascribed to higher US yields denting US growth/tech stocks and triggering a rotation into the more heavily value-weighted equity markets in Europe. Yesterday, US yields rose and US tech stocks dropped but the dollar rallied broadly. 

We would take a more vanilla approach to FX where the proximity of Fed lift-off is triggering bearish flattening of the US yield curve – as the Fed is expected to apply the monetary brakes – which is typically a bullish story for the dollar against low-yielding currencies like the EUR and JPY.  Activity currencies, especially energy exporters,  should be able to better withstand dollar appreciation pressure and it is pleasing to see one of our preferred trends – a lower EUR/CAD – breaking to a new low yesterday.

On the subject of energy – and in addition to supply disruptions – we were taken by a comment made by our commodities team today that OPEC supply increases in December failed to live up to what was agreed by OPEC+. It seems higher energy prices may linger and may delay any sharp turn lower in headline CPI later in the year.

This environment is seeing the scale of expected tightening cycles increase around the world, including in the US. The terminal rate for the Fed Funds cycle is now priced at 1.80% versus 1.60% last week. It has not been a surprise to see the market starting to speculate about 50bp Fed increments.

As we discuss in this month’s FX talking we prefer those currencies backed by hawkish central banks – i.e. those central banks that would prefer strong currencies to ride out the 1H22 inflation hump. Into this category, we would put: USD, GBP, CZK and PLN.

For today, expect the focus to remain on US bond yields and equity markets. Goldman Sachs un-nerved equity markets with a softer trading performance in 4Q than expected. Let’s see if equities can settle a little today, although we do see another round of US bank earnings. Overall we favour DXY continuing its recovery towards the 96.40/50 area.