The EUR continues to perform strongly as negative terms of trade shock eases

EUR: Hawkish ECB comments & improving cyclical momentum provide lift

The euro has continued to strengthen overnight resulting in the EUR/USD rate moving to within touching distance of the year to date high at 1.1076 from 14^th April. The euro has regained upward momentum since late last week supported by further evidence of improving cyclical momentum in the euro-zone. The release of the latest PMI surveys on Friday signalled that the euro-zone economy has likely strengthened at the start of Q2 as last year’s negative terms of trade shock from the sharp rise in energy and food prices continues to fade. It has helped to lift business confidence in the service sector to its highest level since April of last year. The ongoing improvement in the service sector has helped to offset renewed weakness in the manufacturing sector where business confidence has fallen to its lowest level since the initial recovery from the first negative COVID shock in May 2020. For the economy as a whole the composite PMI reading of 54.4 in April has improved by 7.1 points from the low in October of last year. The surveys provide further reassurance that the euro-zone economy will avoid recession and is strengthening heading into the middle of the year.

The resilience of the euro-zone economy will keep pressure on the ECB to tighten monetary policy further with food and core inflation measures also hitting fresh cyclical highs recently. There have been hawkish comments from ECB officials at the start of this week indicating that another larger 50bps rate hike remains a possibility at the next policy meeting on 4^th May.  ECB Executive Board member Isabel Schnabel stated that “data dependence means that 50 basis points are not off the table” with “the data we have so shows that inflation is higher and the economy more resilient than expected”. It follows on from hawkish comments in yesterday’s FT by ECB Governing Council member Pierre Wunsch who stated that “I would not be surprised if we had to go to 4%...we are waiting for wage growth and core inflation to go down, along with headline inflation, before we can arrive at the point where we can pause”. Th comments support the recent hawkish repricing in the euro-zone rate market where the terminal rate is expected to rise closer to 4.00% later this year. The euro-zone rate market still believes though that the ECB is more likely to step down the pace of hikes to 25bps at next week’s policy meeting with 33bps of hikes priced in which leaves room for a hawkish surprise if the ECB delivers a larger 50bps hike.

In light of recent developments, we are more confident that the Fed will pause their hiking cycle before the ECB. The narrowing of yield differentials between the euro-zone and the US has been helping to the euro to strengthen against the US dollar this year. We see room for this move to extend further in the near-term and recommended a new long EUR/USD trade idea in our latest FX Weekly report (click here). The loss of confidence in US regional banks and expected tightening in credit conditions has boosted expectations that the Fed will pause their hiking before the ECB. The release yesterday of quarterly results from First Republic Bank has served as a reminder that concerns over the health of regional banks has not completely gone away. The results showed that customer deposits fell more sharply than expected by 41% to USD104.5 billion in Q1. Their stock price plunged by 22% in late trading in New York. First Republic Bank did though provide more reassuring news that deposit outflows have slowed this month dropping by just -1.7% through to last Friday.    

FRESH DOUBTS OVER CHINA REOPENING TRADES

Source: Bloomberg, Macrobond & MUFG GMR

EM FX: A setback for EM FX as stronger China data offers limited support

Emerging market currencies have suffered a setback over the past week as the USD has staged a modest rebound. The worst performing EM currencies over the past week have been the KRW (-1.9%), the BRL (-1.8%), the CLP (-1.5%) and COP (-1.0%). For the BRL and COP it marks a reversal of recent strong gains after USD/BRL and USD/COP briefly fell towards the 4.9000-level and 4,400.0 levels respectively. In contrast, it marks a continuation of this year’s weakening trend for the KRW as USD/KRW is attempting to break back above resistance from the 200-day moving average that comes in around 1,325.0 for the first time since late last year.  

The disappointing price action for the KRW provides further evidence that China reopening trades are struggling to regain upward momentum this year. Asian currencies have on the whole failed to strengthen further against the USD even as it weakened more broadly. Even the release last week of the stronger activity data from China failed to provide a fresh catalyst for Asian currency strength. It was revealed that China’s economy rebounded more strongly than expected at the start of this year boosted by the release of pent up demand as COVID restrictions were eased. In response our research colleagues from Asia have revised higher their forecast for GDP growth in China this year (click here). Recent weakness in Asian currencies and the KRW could reflect in part geopolitical tensions between China and the US. According to the FT, the US has asked South Korea to urge domestic chipmakers not to fill gaps in the market in China if Beijing bans Idaho-based Micron from selling chips. At the same time, the sharp drop in the price of ore at the start of this week to its lowest level since late last year is casting fresh doubt on the strength of the recovery in demand from China. It follows on from comments last week from China’s National Development and Reform Commission (NDRC) that it would crack down on “unreasonable” price gains in the market and loo to use domestic ore and improve the use of scrap steel.                

One of the key events for EMEA EM FX this week will be today’s NBH’s latest policy meeting. The carry attractiveness of the HUF took a hit last week after Governor Deputy Governor Virag signalled that the NBH may start a “multi-step” normalization of monetary policy in the week ahead. It is too early though to expect rates cuts this week so downside risks should remain contained for now. Deputy Governor Virag stated that the first step today is more likely to be a reduction in the top end of the rate corridor by a significant margin that is currently set at 25%.  Please see our latest EMEA EM Weekly for more details (click here).

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
UK	10:00	BoE MPC Member Broadbent Speaks	--	--	--	!!!
UK	11:00	CBI Industrial Trends Orders	Apr	-20	-20	!!
US	14:00	S&P/CS HPI Composite - 20 s.a. (MoM)	Feb	-0.4%	-0.4%	!!
US	14:30	Building Permits	--	1.413M	1.550M	!!
US	15:00	CB Consumer Confidence	Apr	104.0	104.2	!!
US	15:00	New Home Sales	Mar	630K	640K	!!
US	15:00	Richmond Manufacturing Index	Apr	4	-5	!!

Source: Bloomberg