Cautious comments from Federal Reserve Chair yesterday halted the USD rise and ought to be supportive of high yielding FX during the summer months. Whilst the upside to EUR/USD is bound, cyclical European currencies such as NOK or CZK should do well. We estimate that EUR/GBP is trading near to, yet modestly above, its short-term fair value
USD: Federal Reserve Chair Powell halting the dollar upside
Fed Chair Powell stuck to his mantra of caution in his testimony yesterday and, regardless of the sharply rising US consumer price index (CPI), he noticed that it is too soon to begin thinking about imminent tightening and that any reduction in QE purchases continues to be way off. With the Fed still believing in the transitory nature of inflation pressures and no imminent and premature tightening on the cards, this suggests that high yielding FX (particularly where central banks come in tightening mode – in emerging markets they are BRL, MXN and RUB) should stay supported over the summer months.
For G10 low yielders, such as the EUR or JPY, their upside vs USD ought to be limited, despite Powell's cautiousness, because the start of the Fed's policy normalisation cycle continues to be set to occur meaningfully earlier and be much more pronounced than those for the ECB and BoJ.
EUR: Stabilisation in EUR/USD
Powell's comments yesterday were able to halt the EUR/USD decline but alternatively than trying to find meaningful reversal in EUR/USD, a stabilisation in the pair is much more likely on the coming weeks because the Fed is nonetheless closer to policy normalisation compared to the ECB. Still, the cautious comments from Chair Powell should help to reverse the recent losses in European cyclical FX, such as SEK and NOK, particularly in the case of NOK where we expect the central bank of Norway to boost interest rates twice this year.
In the CEE FX space, CZK continues reversing its previous losses because the hawkish comments from various Czech central bank board members underscore our view that the central bank will deliver yet another three hikes this year.
GBP: Hovering around to its short-term fair value
Both solid UK employment numbers today and June's CPI yesterday were a modest positive for GBP and should keep EUR/GBP in the 0.85-0.86 range for the reminder of the week. Predicated on our short-term financial fair value model, EUR/GBP is trading modestly expensive with our estimate of the short-term fair value at 0.8490. Still, such a mis-valuation is rather modest and supports the case for EUR/GBP to hover round the 0.85 level.
NZD: RBNZ may start hiking already in 2021
Whilst the Bank of Canada tapering announcement didn't surprise industry (we discuss it within our BoC review), the Reserve Bank of New Zealand delivered a really hawkish message at its policy meeting yesterday (here is our RBNZ meeting review note). Policymakers in New Zealand announced that the current asset purchase programme will end by 23 July, a move that has been seen to claim that an interest rate hike can come already in 2021. We think you can find virtually identical chances that the very first 25bp hike could come at the August or October meetings, and much depends on incoming data, namely tomorrow's inflation numbers and the unemployment report in early August, both discussing 2Q21. Consensus is for a 2.7% YoY increase in headline CPI: anything above that number should fuel speculation of an August hike, although we suspect unemployment data will be more essential for the RBNZ considering how it has addressed expected inflation spikes in 2Q and 3Q as transitory.
From an FX perspective, NZD looks set to take advantage of a much better carry earlier than its peers, AUD and CAD. Specifically, the ever-widening policy divergence with the Reserve Bank of Australia suggests much of downside potential for AUD/NZD, where we expect a go on to the 1.04/1.05 region on the coming months.