Monthly Foreign Exchange Outlook

March 2023

KEY EVENTS IN THE MONTH AHEAD

DEREK HALPENNY
Head of Research, Global Markets EMEA and International Securities

Global Markets Research
Global Markets Division for EMEA
E: derek.halpenny@uk.mufg.jp

LEE HARDMAN
Senior Currency Analyst

Global Markets Research
Global Markets Division for EMEA
E: lee.hardman@uk.mufg.jp

LIN LI
Head of Global Markets Research Asia

Global Markets Research
Global Markets Division for Asia
E: lin_li@hk.mufg.jp

JEFF NG
Senior Currency Analyst

Global Markets Research
Global Markets Division for Asia
E: Jeff_ng@sg.mufg.jp

EHSAN KHOMAN
Head of Commodities, ESG and Emerging Markets Research – EMEA

DIFC Branch – Dubai
E: ehsan.khoman@ae.mufg.jp

CARLOS PEDROSO
Chief Economist

Banco MUFG Brasil S.A.
E: cpedroso@br.mufg.jp

MAURICIO NAKAHODO
Senior Economist

Banco MUFG Brasil S.A.
E: mnakahodo@br.mufg.jp

_{MUFG Bank, Ltd.
A member of MUFG, a global financial group}

1）MAJOR CENTRAL BANKS IN FOCUS IN MARCH

After four months of depreciation, the US dollar (DXY) rebounded in February, advancing by 2.7% fuelled by renewed angst over inflation triggered by inflation data that was stronger than expected. Some recovery of the dollar is not surprising after the large sell-off from the highs recorded last September and we suspect further gains are likely over the short-term. Two variables will remain crucial for the markets in March – incoming data on inflation and wages; and the outcome of key central bank decisions. We remain confident that inflation will fall notably over the coming six months but periods of concern over the speed of decline are inevitable. Eight of the G10 central banks will announce monetary policy decisions in March (RBNZ and Riksbank will not) and some of those decisions are reasonably predictable – the ECB +50bps; Fed +25bps; RBA +25bps; Norges Bank +25bps and BoC unchanged. There has been some speculation about another YCC change from the BoJ but we suspect policy will remain unchanged with incoming Governor Ueda left to tackle changing the YCC framework later in the year. The BoE will also probably hike 25bps in March although any surprises to the downside on CPI and wages ahead of that meeting could sway the BoE to remain on hold. The Fed will hike for sure and will be accompanied by strong communication of more to come.

２）UK BREXIT AND BUDGET IN FOCUS

The announcement by the UK government of a deal reached with the EU on changes to the Northern Ireland Protocol will mean this topic is more in focus over the coming weeks. The DUP in Northern Ireland is yet to officially support the deal and PM Sunak has promised to present the deal to parliament for a vote. It will be crucial that PM Sunak achieves a majority not just in parliament but a large majority within his own party. Chancellor Hunt will also present his budget on 15^th March and there is speculation of some potential give-aways to try and rebuild voter support ahead of a general election next year. There was a surprise budget surplus recorded in January providing some leeway for the government. Prospects for the pound are slowly improving and we should see more sustained gains later in the year.

３）FOCUS ON JAN-FEB ECONOMIC DATA, NPC AND CPPCC

The National People’s Congress (NPC) and Chinese People’s Political Consultative Conference (CPPCC) will commence in early March, during which, appointments of the premier, vice-premiers and leaders of state organizations will be announced. Premier will announce GDP growth target, other key economic targets and policies for 2023. Additionally, January and February economic numbers can be important, for us to learn about the growth momentum since China’s change of Covid-19 policy, and this will help project the growth pattern ahead.

Forecast rates against the US dollar - End-Q1 to End-Q4 2023

Notes: All FX rates are expressed as units of currency per US dollar bar EUR, GBP, AUD and NZD which are expressed as dollars per unit of currency. Data source spot close; Bloomberg closing rate as of 4:30pm London time, except VND which is local onshore closing rate.

US dollar

MARKET UPDATE

USD recoups some losses

In February the US dollar strengthened against the euro in terms of London closing rates, moving from 1.0866 to 1.0612. In addition, the dollar strengthened versus the yen, from 130.08 to 136.15. The FOMC met at the start of February and the fed funds rate was raised by 25bps to 4.50%-4.75%, following 425bps of rate hikes last year. The FOMC has also continued with its policy of shrinking its balance sheet with QT ongoing at a pace of USD 95bn worth of UST bonds (USD 60bn) and MBS (USD 35bn) of balance sheet reduction each month. However, MBS roll-offs are falling short of that plan given larger early repayments.

OUTLOOK

USD rebound as inflation angst returns   

After a 1.4% (DXY) drop for the dollar in January, we saw a bigger rebound in February as US yields jumped sharply on the back of stronger than expected data on the jobs market and inflation. We began 2023 with a profile of USD strength in Q1 as we believed a linear straight-line depreciation of the dollar was unlikely and given the scale of dollar weakness in the four months from October last year, some rebound was likely. The 517k increase in nonfarm payrolls in January was the start of the move stronger and while January was the 5^th warmest on record clearly exaggerated the scale of labour market strength, the data still confirmed continued jobs market strength. But it was the mixed CPI report and then the much stronger PCE inflation data that really extended the move stronger. In particular, the much-focused-on core PCE services excluding housing was stronger than expected with the 3mth average of MoM changes accelerating to 0.5%, the largest gain since 1988. The strong retail sales data for January also means the economy will prove more resilient in H1 2023 leading to recession timing be pushed back or abandoned. 

Fed hawkish rhetoric justified now but we still expect caution on over-tightening to increase

The higher rates / stronger dollar impact was certainly reinforced by the continued hawkish rhetoric by Fed officials. The terminal rate for the fed funds has now drifted up to about 5.40% - implying a little more than three 25bp hikes are fully priced. We believe there are good grounds for the FOMC to hike at the next two meetings in March and May (there will be only one month of data between these meetings) but by June two additional months of data will be available when inflation will be declining more notably and the labour market slowing mean a pause by June is still feasible.  The Dec 2023 fed funds future has seen the implied rate jump by a huge 78bps in February alone underlining the shift in thinking on the timing of monetary easing. The first cut has now been pushed into 2024, but we still see risks of easing in Q4.

Weaker USD view still holds

We are somewhat cautious on reading too much into one month of data, a month of unusually warm weather in the US. Inflation still looks set to fall notably over the coming months and the US labour market is likely to slow. Further US dollar strength seems likely over the short-term but we have just corrected weaker from over-valued levels and hence we doubt this move will be sustained. Spreads have only marginally moved in favour of the dollar and remain consistent with USD depreciation.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

Hopes for a Fed pause have taken a hit but all is not lost.

US rates have adjusted sharply higher in February in response to stronger US activity and inflation data at the start of this year. Recent developments have made market participants wary of the risk that higher inflation could prove more persistent and require the Fed to keep higher rates in place for longer. Expectations for the terminal policy rate have climbed to a cyclical high of just over 5.4% from around 4.8% at the end of January. While we acknowledge that there is now a higher risk that the Fed delivers another 25bps hike at the June FOMC meeting, we are sticking to our central forecast for only two further 25bps hikes in March and May. We suspect that recent stronger US data is exaggerated relative to the underlying strength of activity and inflation. Fed Chair Powell has continued to signal that he remains comfortable with plans for a couple more hikes. We expect clearer evidence to emerge of softer US growth and inflation in the year ahead. Our forecasts for the Fed to begin cutting rates is based on the assumption that the US economy falls into recession. We continue to believe that US rates in the process of peaking out.      

Hawkish repricing of Fed rate hike expectations helps USD to rebound  

DXY vs. short-term yield spreads

Services inflation is proving stick so far

US core services inflation excluding housing CPI vs PCE deflator

Japanese yen

MARKET UPDATE

JPY weakens

In February the yen weakened versus the US dollar in terms of London closing rates from 130.08 to 136.15. In addition, the yen weakened versus the euro, from 141.34 to 144.48. The BoJ did not meet in February and hence the monetary stance was unchanged with the key policy rate at -0.10% and YCC maintained, restraining the 10-year yield within a range of +/-50bps around zero percent. The 10-year JGB yield continued to test the 0.50% upper limit.

OUTLOOK

Ueda provides hope of status quo   

The shock announcement of the initially unknown Kazuo Ueda being nominated as the new Governor of the BoJ fuelled JPY volatility but once market participants assessed the implications in more detail, the yen weakened sharply – indeed the yen was the 2^nd worst performing G10 currency in February. In a way, February was a month in which the markets returned to the drivers of 2022 – high inflation angst, rising US yields and broader US dollar strength. But we are sceptical of this return to the 2022 dynamics as being sustained going forward. Yes, Kazuo Ueda appears to be a very good choice – he is a credible academic, well positioned to deal with the difficult task of changing policy after the Kuroda-era under Abenomics. Ueda has signalled a high level of caution in making changes which has fuelled expectations of status quo on BoJ policy lasting longer. But YCC as a policy framework is no longer working given the distortions and dysfunctional trading conditions that have evolved as upward pressure on yields increase. We suspect there will still be an urgency in changing the framework and that could quickly change the negative sentiment on the yen that has re-emerged since Ueda’s nomination. His nomination hearings suggest caution but equally suggest change is likely coming

Inflation and wage data in focus

The caution on policy changes expressed by Ueda are well justified – the annual CPI rate at 4.2% is made up predominantly of higher food and energy prices which will soon begin to correct lower. Food and utility prices (predominantly energy) make up 73% of the 4.2% increase. Ueda stated in his nomination hearings that any exit policy would be dictated by economic conditions. Wage growth is now accelerating with the 6mth average of the annual change in regular wages (ex-bonus) at 1.6%, the highest since 1997. Finally, it is worth highlighting one additional comment from Ueda in his nomination hearings – that it is sometimes difficult for central bankers to avoid surprises. That is worth remembering as we move forward over the coming months.

Yen strengthening trend will resume

The underperformance of the yen in February is unlikely to become sustained and we maintain that the inflation angst that has emerged globally will not return to anything like during period of last year when JPY depreciated sharply. Since the dollar peaked at the end of September, JPY has been 2^nd best performing G10 currency to end-January. Some retracement in that context is understandable. But we maintain inflation will subside from here and yields globally are close to peaking which point to JPY recovery, especially with BoJ policy set to change as well.

INTEREST RATE OUTLOOK

YCC still set to be removed despite cautious tone from Ueda

We maintain our 10yr JGB yield forecast profile and expect an end to YCC in Q2 that should see the 10yr JGB yield peak then before subsiding as inflation globally subsides. The risk to this view is clearly that the decision of the BoJ to end YCC could come later than we anticipate. The comments from Kazuo Ueda in the Diet at his nomination hearings do suggest caution and Ueda’s past period at the BoJ (1998-2005) does reveal a level of caution over changing policy too soon. He was against raising interest rates in 2000 and history shows that was the correct stance. However, YCC is creating dysfunctional market conditions and it is now questionable that the policy has much net benefits for the real economy. Ueda did also state that changes to policy could contain “surprise” – this is inevitable as to provide any hint of change would simply fuel speculation and place YCC under strain. Hence, we need to take the comments from BoJ officials with a degree of caution given YCC would never end with any degree of forward guidance.

Rising yields outside of Japan have weighed down on JPY again   

USD/JPY vs. Japan’s 10-year swap rate

Speculators are still anticipating further JPY upside on shift in BoJ policy

Three-month USD/JPY Risk Reversal 

Euro

MARKET UPDATE

EUR corrects weaker

In February the euro weakened further versus the US dollar in terms of London closing rates, moving from 1.0866 to 1.0612. The ECB at its meeting in February raised the key policy rate by 50bps to 2.50% following 250bps of tightening last year. That was the most aggressive tightening in a year by the ECB and will be augmented by further hikes and QT going forward. The ECB is scheduled to commence QT in March with a EUR 15bn per month reduction in APP through to June.

OUTLOOK

ECB remain concerned over inflation risks helping push yields higher

The euro depreciated against the US dollar in February after four consecutive months of appreciation as US yields jumped notably on the back of renewed inflation fears and stronger than expected data. There was a particularly sharp drop in EUR/USD in response to the stronger than expected US jobs report. However, since then rising yields in the US have been broadly matched by rising yields in the euro-zone as well which has limited the scale of EUR depreciation. The estimated terminal rate drifted notably higher in February – by the end of this year, the estimated policy rate increased by 55bps to 3.88% with inflation angst not just related to US Inflation data. The euro-zone core CPI rate was revised higher, from 5.2% to 5.3%, which will only reinforce fears over sticky inflation going forward. The euro-zone household is also benefitting from the fall in energy prices that has seen growth proving more resilient. Consumer confidence in the euro-zone ticked higher in February to -19, the highest level since February 2022 before the collapse in confidence due to Russia’s invasion of Ukraine.

ECB unlikely to hike the policy rate to 4.00% where markets are currently priced

Like with the FOMC, the tone from the majority of Governing Council members at the ECB has remained hawkish. This is not going to change until we have had a more marked decline in actual inflation. A 50bp hike in March is assured and we now believe a further 50bps of tightening will be undertaken, implying a terminal rate of 3.50% (prior view was 3.00%). But we still maintain that the ECB will hike by less than what is currently priced into the market – close to 4.00% policy rate peak. While the euro-zone economy is performing better than expected a few months ago, recessionary conditions will likely prevail which will help ease demand and alleviate the upward pressures on core inflation. Q4 GDP in Germany contracted by 0.4% Q/Q and recession seems likely now despite the fall in natural gas prices. We would also expect some lowering of the 2024 inflation forecast of 3.4% in March.

EUR/USD to drift higher later in the year

As we had expected, the US dollar has rebounded and EUR/USD is set to fall modestly further from here as inflation risks turn higher again. However, despite the substantial jump in US yields, spreads with Europe have moved only modestly and in general, EUR/USD is trading at an appropriate level based on historic spreads. In addition, the end of negative rates in the euro-zone and the scope for euro-zone equity outperformance relative to the US point to the potential for EUR/USD to grind higher later this year. The ECB is set to be on hold for longer than the Fed

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

Inflation still set to fall notably which will help bring yields lower

The 10-year German bund yield jumped notably in February, by 36bps to close at 2.65%, a new cyclical high and the highest level since July 2011 when yields were falling as the euro-zone debt crisis worsened. Renewed inflation angst, fuelled by higher than expected inflation data and reinforced by continued hawkish ECB rhetoric were the primary factors behind the move. We now see the terminal rate being 50bps higher than previously expected at 3.50%, with two 25bp hikes at the meetings in May and June adding to the 50bp hike expected in March. By July, the ECB will have had five additional months of inflation data which by then we believe will provide enough confidence to allow the ECB to pause. Core inflation has drifted higher but this is normal – core inflation lagged overall inflation in the move higher and will lag in the move lower as well. ECB Chief Economist Philip Lane remarked on the increasing evidence of inflation “at the intermediate level” starting to show signs of easing. 10yr Bund yields could well drift higher from here over the short-term but more sustained signs of falling inflation will help bring yields lower in H2 this year.   

Hawkish ECB repricing helping to keep EUR at stronger levels

EUR/USD vs. short-term yield spread

No evidence yet that core inflation has peaked unlike headline rate

Headline vs. core inflation

Pound Sterling

MARKET UPDATE

GBP corrects weaker versus USD, stronger versus EUR

In February the pound weakened against the US dollar in terms of London closing rates from 1.2320 to 1.2116. However, the pound strengthened modestly against the euro, from 0.8820 to 0.8759. The BoE at its meeting in February raised the official Bank rate by 50bps to 4.00%, following 325bps of rate hikes last year. The BoE commenced QT in November and completed in January the sales of Gilts purchased under the emergency purchase program following the turmoil in September and October when a poorly delivered fiscal plan caused a crisis of confidence.

OUTLOOK

Finally, some good news on Brexit

The pound was the 2^nd best performing G10 currency in February and while it weakened versus the US dollar it outperformed nearly all other G10 currencies (bar SEK). The forward-looking economic data provided some good news with the advance PMIs much stronger than expected – the Composite PMI jumped 4.5ppt to 53.0, suggesting more robust economic growth going forward. Annual core CPI also fell more sharply, from 6.3% to 5.8%. But it was the progress on a new Northern Ireland Protocol deal with the EU that could prove most significant going forward. The FX reaction to the deal has been muted as in isolation this has limited macro implications – Northern Ireland is just 2% of UK GDP. However, if this deal marks the beginning of improved, more constructive relations between the UK and the EU, it may result in other changes in trade arrangements that reduce more widely the frictions in trade that has been a negative for UK growth. Extended grace periods on tariff free trade, mutual recognition on product quality standards, a possible easing of strict cross-border checks on food trade, and more collaboration on energy policy would certainly help sentiment and remove some of the negativity related to Brexit uncertainty. The re-entry of the UK into Horizon Europe was one immediate consequence of this deal. We assume wider Conservative party support although DUP opposition could persist, dampening some of the optimism related to the deal.

BoE guidance on rate hikes becomes more conditional

The outlook on rate hikes by the BoE has become less clear following the 50bp rate hike in February when the BoE made future rate increases conditional on “evidence of more persistent pressures” relating to inflation linked to tightness of the labour market, wage growth and services inflation. With services inflation down sharply (6.8% to 6.0%) but wage growth higher than expected (3mth avg YoY 6.7% from 6.5%) the decision to hike again is finely balanced. The one-month wage data actually decelerated which to us should tip the balance in favour of the BoE holding steady. March data will be important of course but at the margin (given market pricing) we assume one further “insurance hike” of 25bps to 4.25%.

Trend stronger for GBP later in the year 

We maintain our view of short-term downside risks as inflation remains a concern and risk conditions remain fragile. However, assuming inflation falls notably and the Brexit deal just agreed improves relations with Europe, we see scope for some GBP outperformance after a sustained period of negativity for the UK.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

Approaching pause

After two months of sharp decline in 10-year Gilt yields, February saw a renewed bounce as global inflation angst returned – the 10-yr yield increased 50bps to close at 3.83%. The move though was more in sympathy with developments in the US and the euro-zone. In both regions, inflation data was stronger than expected, unlike in the UK. The OIS market implies a further 80bps of tightening by the BoE. However, we believe the BoE is much closer to pausing and indeed will pause before the Fed and the ECB – a scenario reflected by the more conditional guidance on rate hikes by the BoE. The BoE’s current forecasts for inflation are 0.95% in 2yrs and 0.37% in 3yrs – way below the 2% target rate and hence also implying a greater risk of a pause sooner than elsewhere. The risk to the pound and the Gilt market from pausing before elsewhere also appear lower now. Foreign investors have returned to the UK Gilt market with over GBP 38bn worth of Gilt purchases in December, offsetting the sale between September and November. Government budget data were also positive with a surprise surplus recorded in January. 10yr Gilt yields could drift further higher in the near-term but yields should decline later in the year

GBP remains tightly linked to changes in global risk sentiment 

GBP performance vs. Global financial equities

ECB is expected to keep hiking for longer than BoE putting upward pressure on EUR/GBP

EUR/GBP vs. short-term yield spread

Chinese renminbi

MARKET UPDATE

The CNY weakened against the USD in February

In February the Chinese yuan depreciated by 2.6% against the US dollar to 6.9330. For the sixth consecutive month, PBOC kept its 1-year MLF rate unchanged at 2.75% on 15^th February and held 1-year LPR and 5-year LPR unchanged at 3.65% and 4.30% respectively on 20^th February.

OUTLOOK

A stronger dollar and US-China tensions drove CNY weaker.

February was a month of limited economic data releases and hence the yuan’s losses were largely pressured by the US dollar’s strengthening fuelled by market’s bet on more Fed rate hikes. Data shows that new home prices in 70 Chinese cities held steady in January, ending a 16-straight-month of m-o-m decline, but the existing home prices continued to decline by 0.28%mom this January. Signs of improvement in the country’s property market was largely helped by the government’s stimulus measures which will likely become more evident. A potential improvement in medium term activities is implied by January credit data as well, with new medium- & long-term yuan loans RMB880 billion higher than in January 2022. Notably, compared with a year ago, new medium- & long-term corporate lending was RMB1.4 trillion higher this January, while the new medium- & long-term household borrowing was RMB519.3 billion lower. January’s weak medium- & long-term households borrowing implied still weak property purchases, which means a continued effort by the government is needed to stimulate households’ property demand. The government has been acting on it. On 20^th February, the China Securities Regulatory Commission announced a pilot scheme to boost equity financing in the property sector, allowing qualified private equity investors to set up funds to invest in residential property, as well as commercial real estate and infrastructure, and is set to encourage foreign investors to participate via the Qualified Foreign Limited Partnerships. In addition, PBOC and the China Banking and Insurance Regulatory Commission jointly released a draft guideline on 24^th February introducing 17 new measures to strengthen financial support for rental housing market. Meanwhile, Wuhan on 6^th February announced to allow local households to buy an additional home in the city, the first major Chinese city to relax rules limiting home purchase to prop up property sales.

China’s January and February data published in mid-March can be important in understanding China’s recovery pace.

More notably, the CKGSB Business Conditions Index measuring China’s private small businesses surged to 57.6 in February, with sales, profit and financing sub-indexes rebounding to 73.1, 58.7 and 54.3 respectively, the latest signs of recovery for the Chinese economy after the abandonment of “Zero-Covid” policy in December. Market is now awaiting February PMI data due for more clues on the pace of China's recovery. The National People’s Congress on 5^th March is expected to announce 2023 GDP growth target, other key targets, and economic policies for this year. In March, we see China’s fundamentals, dollar’s movement and US-China tensions will continue to drive the yuan’s sentiment and volatility.

INTEREST RATE OUTLOOK

* Interest rate assumptions incorporated into MUFG foreign exchange forecasts.

A moderate increase in China’s 10 year government bond yield down the road

China’s 10-year governemnt bond yield was little changed at 2.91% last month as optimism on China’s reopening stalled with a lack of fresh catalysts. The PBOC pledged to strike a balance between boosting domestic demand and preventing inflations risks when providing support for the real economy this year, adding that it will refrain from using “flood-style” stimulus and that prudent monetary policy will be targeted, forceful and maintain an effective credit growth, as stated in its fourth-quarter monetary policy implementation reported released on 24^th February. We expect no cut on various policy rates in the near-term given these refreshed policy stances. In February, China's local governments issued net RMB331.9 billion worth of special bonds, down from January’s RMB491.2 billion, indicating a smaller boost in funding for infrastructure projects. Investors are still looking for more evidence of China’s recovery, suggested by a cut in foreign investors’ holdings of Chinese bonds in January after a sharp rebound in December. Having said that, given the prospects of a gradual recovery, we see the 10-year government bond yield rising modestly.

Signs of improvement in property sector show in January

CHINA’S NEW HOME PRICES HELD STEADY IN JANUARY

Source: Bloomberg & MUFG GMR

Household sentiment remained weak this January

NEW INCREASED HOUSEHOLD LOANS WERE LOWER THAN LAST JANUARY   

Source: CEIC & MUFG GMR

Australian dollar

AUD weakens

In February the Australian dollar depreciated against the US dollar in terms of London closing rates from 0.7054 to 0.6751. The RBA at its meeting in February raised the official policy rate by 25bps to 3.35%, following 300bps of rate hikes last year. Further hikes are expected going forward.

Downside correction should fade in H1 with better prospects beyond   

After a positive January, the Australian dollar turned lower in February and wiped out all the gains for the year and some more as global risk sentiment deteriorated as US yields surged higher. The US PCE inflation drove US 2yr yields to a new cyclical high. The Australian dollar was the worst performing G10 currency in February. The outcome for AUD could have been worse but for the more hawkish RBA that prompted market participants to adjust higher the estimated terminal rate. The peak rate expectation jumped 45bps to about 4.20% with the RBA describing inflation as having “more breadth and persistence”. This was evident in the Monetary Policy Statement with the forecast for inflation showing a slowdown to 6.8% by June, versus a previous forecast of 6.3%. However, it remains unclear whether the RBA will tighten to the extent as priced. We certainly see 50bps more now from here but the wage data released in February for Q4 was weaker than expected, slowing from 1.1% to 0.8% Q/Q. With the Fed rhetoric so hawkish we suspect over the short-term, we can see further downside for AUD/USD. China data will be important in March covering Jan/Feb and we may well see evidence of pent-up demand post re-opening that may help limit AUD downside. China commodity-related demand and the scope for the Fed to pause at some point in Q2 should add to a renewed upturn in demand for AUD in H2 this year.

China reopening trades have lost upward momentum in February

AUD/USD vs. performance of Chinese equities

New Zealand dollar

MARKT UPDATE

NZD corrects weaker

In February the New Zealand dollar depreciated against the US dollar in terms of London closing rates from 0.6468 to 0.6199. However, the New Zealand dollar strengthened against the Australian dollar from 1.0906 to 1.0890. The RBNZ at its meeting in February raised the key policy rate by 50bps to 4.75%, following 350bps of rate hikes last year. 

OUTLOOK

Over-tightening fears could come to undermine NZD

After a solid start to the year, the New Zealand dollar reversed course in February and wiped out all the year-to-date gains and some more as risk aversion increased and the US dollar strengthened more broadly. The New Zealand dollar was the 3^rd worst performing currency in February despite the fact that the RBNZ maintained its hawkish approach by tightening by a further 50bps and still suggested more to come. However, there were some subtle changes in language that market participants picked up on as signs of less conviction in future tightening plans. While the RBNZ maintained its view that the policy rate would need to be raised to 5.50%, Governor Orr stated that the RBNZ was in a “more flexible position” – this points to the potential for a slowdown in the pace of tightening to 25bp moves, which we believe lowers the prospect of reaching the 5.50% level. The housing market continues to suffer from the tightening already implemented – building permits are trending weaker with three consecutive declines on a 3mth MAV basis, the worst performance since 2018. Still, evidence of weakness in other areas of the economy is not as clear and hence further hikes seem likely. NZD downside will persist for now reflecting broader risk aversion and when the US dollar begins to weaken again more broadly, NZD may underperform AUD as such aggressive tightening hits the economy.

RBNZ sticks to hawkish rate guidance supporting NZD

AUD/NZD vs. short-term yield spread

Canadian dollar

CAD weakens

In February the Canadian dollar weakened versus the US dollar in terms of London closing rates, from 1.3324 to 1.3605. The Bank of Canada did not meet in February and hence its key policy rate remained unchanged at 4.50%, which followed a 25bp rate hike in January and 400bps of hikes last year. 

OUTLOOK

CAD resilience but underperformance should emerge later in the year

The Canadian dollar was the third best performing G10 currency in February after the US dollar and Swedish Krone and on a year-to-date basis, only the US dollar has outperformed. The economic resilience on show in February certainly helped provide CAD with support. The 150k in employment in January was way above expectations – given the relative sizes of the US and Canada labour markets, the Canada gain was equivalent to a 1.2mn NFP gain in the US. Overall retail sales were also resilient reflecting strong auto sales and there is evidence that household spending could prove stronger than expected. Many Canadian households received government cheques to protect against inflation and reduced childcare fees for many will also help disposable income. Certainly, if the BoC were compelled to recommence tightening, CAD levels would likely be stronger than we assume going forward. However, we do not expect that and suspect the monetary tightening will begin to slow the economy. The BoC will also be relieved to have seen the softer January CPI data – MoM core CPI has averaged 0.067% over the last three months. The stronger domestic data but weaker inflation will be enough to keep the BoC on the sidelines and hence USD/CAD is likely to be more driven by external factors for now and with 2yr UST bond yields at cyclical highs and Fed rhetoric so hawkish, we see upside USD/CAD risks over the short-term before CAD can recover. Slower US growth will likely see USD/CAD lower later in H2 with CAD underperforming non-USD G10 FX.

CAD stages rebound alongside USD at the start of this year.

Performance of CAD vs. other G10 FX

Norwegian krone

MARKET UPDATE

Modestly weaker

In February the krone weakened against the euro in terms of London closing rates from 10.854 to 10.962. The Norges Bank maintained the key policy rate at 2.75%.

OUTLOOK

Weak start to the year followed by recovery 

The krone has continued to underperform at the start of the new calendar year. It has been the worst performing G10 currency so far in 2022 which has resulted in NOK/SEK falling closer to parity for the first time since the end of 2021. However, the scale of recent krone weakness appears overdone relative to normal short-term fundamental drivers. According to our short-term valuation model estimate, EUR/NOK should be trading closer to the 10.500-level rather than the 11.000. It has been a challenging external backdrop for the krone in February. The sharp move higher in global yields has triggered a deterioration in global investor risk sentiment. MSCI’s global equity index has fallen by over 5% from its recent peak which has weighed on more on high beta G10 currencies such as the krone. In addition, the krone has been hurt by the ongoing decline in energy prices at the start of this year. The price of Brent crude oil continued to trade at just above USD80/barrel while the price of natural gas in Europe has fallen to fresh year to date lows. Recent optimism over stronger than expected global growth has not yet fed through to higher and energy and commodity prices more broadly. Another fundamental driver that is continuing to place downward pressure on the krone relative to the euro and Swedish krona is the ongoing shift in monetary policy expectations between the Norges Bank and other regional central banks. The Norges is expected to pause their hiking cycle before the ECB and Riksbank. We expect the Norges Bank to deliver at least one more 25bps hike in March after core inflation hit a fresh high of 6.4% in January.   

NOK weakness at start of this year appears overdone

EUR/NOK vs. short-term model valuation estimate

Swedish Krona

MACRO UPDATE

Modestly stronger

In February the krona strengthened against the euro in terms of London closing rates from 11.362 to 11.062. The Riksbank raised the repo rate by 0.50 point to 3.00%.

OUTLOOK

SEK undervaluation to ease but downside risks remain in near-term

It has been a volatile month for the krona in February. EUR/SEK initially hit a fresh year to date high at 11.443 as the krona fell below the initial COVID lows from March 2020. The krona has since staged a sharp rebound triggered by a significant hawkish shift in the Riksbank’s policy stance. The Riksbank’s tolerance for krona weakness reached its limit at the start of February and prompted it to send a strong signal that it desires a stronger krona to help dampen upside inflation risks. Unease over elevated inflation in Sweden has continued to increase over the past month even as the annual headline rate eased to 11.7% in January. The Riksbank stated that they were worried by the rise in core inflation (CPIF excluding energy) to a new cyclical high of 8.7%. The surprising strength of underlying inflation pressures has reinforced expectations that the Riskbank will have to keep raising rates further than planned.  The Riksbank has signalled that they plan to raise rates to a higher peak of closer to 3.25% which already appears too cautious. The Riksbank is hoping as well that it won’t have to raise rates much further to dampen inflation and support the krona given that the negative trade-off will be that higher rates increase downside risks for Sweden’s economy and housing market. House prices have already fallen sharply by over 15% from their peak and GDP flat-lined in 2022. The Riksbank has also decided to bring forward plans to start asset sales as another way to tighten monetary policy. From April, the Riksbank will start selling SEK3 billion/month of nominal government bonds and SEK0.5 billion/month of real government bonds.

Riksbank has signalled that it will provide more support for SEK

EUR/SEK vs short-term yield spread

Swiss franc

MARKET UPDATE

CHF modestly stronger

In February the Swiss franc strengthened modestly versus the euro in terms of London closing rates from 0.9968 to 0.9936. The SNB did not meet in February and hence the key policy rate remained at 1.00%, following 175bps of rate hikes last year.

OUTLOOK

Weaker CHF on growing optimism in Europe

The Swiss franc remained in a relatively tight range in February after initially strengthening from above parity versus the euro. For most of the time since last October, EUR/CHF has traded within the range 0.9800-1.0000 which has been broadly consistent with the improved risk sentiment following the sharp decline in natural gas prices in Europe and more recently the re-opening of China. We have not yet seen any renewed CHF demand given the worsening of risk sentiment evident by the 2.6% drop in US equities as US yields marched higher to new cyclical highs at the short-end of the curve. Renewed CHF strength versus EUR seems the greater risks over the short-term, especially if EUR/USD continues to drift back toward parity. The SNB will meet in March and we expect a 50bp hike to 1.50%. This could prove the peak but there is a risk of possibly one further 25bp hike to 1.75% in June – based on our assumption of the ECB hiking to 3.50%. The SNB in December projected inflation to be at 2.1% in Q3 2025, rising from 1.8% in Q3 2024. This clearly suggests not much more tightening is required. The SNB is however also using FX to help fight inflation and has been selling foreign currency bought previously when fighting deflation risks. This is likely to continue and hence euro-zone growth improvement after a weak H1, and improved broader risk sentiment as inflation declines will only have a limited impact on weakening CHF.

Recession fears have eased in euro-zone weighing on CHF

EUR/CHF vs. performance of more cyclically sensitive European equities

For other currencies outlooks, please download the PDF version attached at the top of this page.