Welcome to Forex Friday, a weekly report where we discuss selected currency themes primarily from a macro perspective, but we also add a dash of technical analysis here and there. In this week’s edition, we discuss the potential for EUR/USD to drop to parity, following in the footsteps of CHF/USD.
Interest rate differentials continue to move the currency markets as one would expect. Investors buy the currencies of countries where the central bank is expected to raise interest rates the most and sell the currencies of countries where the central bank is expected to remain most accommodative. Here is my colleague Joe Perry’s take on the central bank’s rate hike expectations.
USD/JPY pauses at 130
We have already seen USD/JPY surge to 130.00, rising some 1,500 pips in the space of a few months, as the divergence between the monetary policy positions of the Bank of Japan and the US Federal Reserve is getting bigger.
Looks like we’ll have more Rate hikes of 50 basis points in June, July and September, before returning to standard hikes of 25 basis points thereafter. It is likely that the Fed will suspend its hike in early 2023, or even sooner if the economy were to fall sharply.
But due to risk sentiment deteriorating, some yen pairs sold off, which helped keep USD/JPY balanced this week, even as the dollar appreciated against other currencies. .
USD/CHF breaks parity
One of these currencies mentioned above was the Swiss franc. As the sell off took place, USD/CHF surged above 1,000. It veered 9% or 830 pips in the space of 1.5 months. Awesome stuff. Traders expect the Federal Reserve to raise the target federal funds rate to nearly 2.00% by July and nearly 3.00% by the end of the year, as the U.S. inflation hit multi-decade highs of 8.5% before edging down a bit in April to 8.3% – even higher than expected. This kept the dollar in strong demand across the board, even sending gold down to $1800 today.
In stark contrast, the Swiss National Bank hasn’t changed its monetary policy at all, and why would it when inflation is only 2.5% when it was below target? of the SNB for a very long time. The SNB likes to follow policy changes at the ECB, in order to prevent the EUR/CHF from weakening significantly. So there’s a good chance that the SNB will follow in the footsteps of the ECB to normalize policy a bit by exiting negative rates by Q1 2023. The first rate hike isn’t likely to happen anytime soon – at most early in the third trimester.
Against this fundamental backdrop, one would expect USD/CHF to continue rising over time, although it has now reached my primary target of 1,000. If the weakness in the global economy persists, this would discourage the SNB from raising rates above zero, which could then lead to further losses for the CHF.
What about EUR/USD?
Well the selling has stalled around 1.0350-1.0400 for now. But fundamentally, nothing has changed to suggest a sharp rebound is on the cards. Incoming data from Germany, Europe’s largest economy, continues to deteriorate, even as we inch ever closer to the first ECB rate hike. But will investors start to think beyond short-term rate hikes?
Investors are preparing for a possible ECB hike in July, followed by another in September. But beyond that, it’s hard to see whether the increases will continue given the high levels of uncertainty surrounding the economic outlook. We could see the ECB accelerating the hikes like the rest of the banks that have launched their own hiking cycles.
But one thing is certain, inflation continues to cause major headaches for ECB officials. Thus, they recognize the need to end net asset purchases and the era of negative deposit rates, but longer-term macro factors suggest that any upside cycle may be short-lived.
Unless of course we see a massive rebound in economic activity, for example, due to a potential return to peace in Ukraine and falling oil prices. We already know that demand for holidays in Europe is going to be strong, despite soaring prices, as people who have postponed their holidays in the past two years have traveled to the beaches and sunny weather of southern European countries. ‘Europe. This will increase the demand for euros.
For this reason, I don’t expect to see much more weakness in the EUR/USD exchange rate, although I cannot rule out a return to parity.
Source for all charts used in this article: StoneX and TradingView.com
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