perspectives d’investissement

    Fed’s hawkish tilt may not fetter the euro

    Fed’s hawkish tilt may not fetter the euro
    Vasileios Gkionakis, PhD - Responsable de la stratégie FX globale

    Vasileios Gkionakis, PhD

    Responsable de la stratégie FX globale
    Kiran Kowshik - Stratège marchés des changes

    Kiran Kowshik

    Stratège marchés des changes
    Homin Lee - Stratège macro senior

    Homin Lee

    Stratège macro senior
    Sophie Chardon - Stratège cross-asset

    Sophie Chardon

    Stratège cross-asset

    Key highlights

    • The dollar strengthened across the board following a surprise hawkish tone from the Fed. We expect this strength to remain in place near term; medium term, however, we expect USD downside bias to resume due to the strong global growth dynamics
    • The rise in US yields at the short end of the curve will likely cause soft trading in the euro-dollar for now. Further out, we still expect some appreciation to reemerge as euro-area growth gathers pace
    • Euro/Swiss franc should reach 1.12 by year-end. Meanwhile, we are turning more neutral on the dollar-yen. We maintain a neutral stance on sterling
    • While recent months have been characterised by supportive emerging market FX conditions, we believe the remainder of the year could be more challenging. The renminbi remains our top pick.

    The Federal Reserve (Fed)’s June meeting was the highlight of the month. As the central bank maintained its monetary policy, the hawkish surprise came from its interest rate projections. The Federal Open Market Committee (FOMC) now projects two 25-bps hikes in 2023 (vs none previously), bringing its forecast more in line with market pricing.

    However, this move represented a somewhat hawkish shift, since it portrays a central bank that is no longer pushing back against market expectations.

    Medium term, we still think the path of least resistance is for the dollar to gravitate somewhat lower under the strong impetus of global growth

    The immediate market reaction therefore saw the dollar surge against G10 and EM currencies. Equities fell, US 2Y yields rose, and the yield curve flattened. The Fed’s move upset our FX views, and we thus now expect USD upside pressure to persist in the near term. Medium term, however, we still think the path of least resistance is for the dollar to gravitate somewhat lower under the strong impetus of global growth.

    Regarding the euro-dollar (EURUSD), we maintain our forecasts unchanged, although in the near term we expect downside pressures to persist as USD bullish sentiment builds up. However, for the medium term we would not throw in the towel on EUR appreciation just yet. The currency tends to perform very well in periods of cyclical growth upswings, similar to the one currently underway. EURCHF is likely to reach 1.12 by the end of the year, in our view.

    Turning to sterling, we maintain a neutral stance. We still expect structural Brexit-related headwinds to keep pressure on the GBP. The main risk to this view is an earlier tightening of monetary policy by the Bank of England.

    We have raised our USDJPY forecasts, as the hawkish Fed and sizeable outward Japanese M&A activity will weigh on the yen for the time being.

    For EM currencies …we are likely entering a more challenging period. Caution is warranted for EMFX exposure

    The Nordics are likely to sustain losses in the short term, but growth rotation towards Europe should allow appreciation in H2 21. A similar pattern should occur in the core commodity FX G10 bloc (AUD, CAD, and NZD), which should find some support further out on rising commodity prices. For emerging market currencies, while conditions had been supportive given stable US real yields and positive EM data surprises, we are likely entering a more challenging period. Accordingly, caution is warranted for EMFX exposure, but we continue to favour the RMB as our top pick (see FX ISB - Stress-testing our constructive renminbi view).

    In terms of the EMFX path ahead, we believe the 2013 “taper tantrum” playbook may not work given better global trade growth and commodity price momentum in 2021 as well as improved EM external balances. However, in recent years, we do find a number of currencies that are more sensitive to US yields. These include the TRY and HUF (CEEMEA), IDR and INR (Asia), and CLP and COP (LatAm).

    Main risks to our view: The main upside risk to our forecasts comes from a stronger recovery in global trade that could support bigger and broader rallies in the G10 and emerging markets. On the downside, we see the following risks: First, further rapid increases in US yields (a US “yield tantrum”). Second, the Fed gradually turning more hawkish. Third, a premature withdrawal of global fiscal support.

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