Central banks rushing to remove the punchbowl

Market overview

Fed hiked rates by 75bp, ECB pre-announced rate hikes

High inflation and commodity prices have been a theme all year, which was also highlighted with the release of US CPI reaching 1% m/m over one month. Advanced central banks are raising rates. The Fed raised interest rates by 75bp – the largest hike since 1994. The SNB hiked interest rates by 50bp (predicted by no-one in consensus) and the ECB is now firmly communicating rate hikes all the way through 2022. Norges Bank also hiked by 50bp. This highlight how global inflation pressures remain persistent. Demand is simply too high relative to global production capabilities and central banks no longer have the luxury of easing policy amid the risk of de-anchoring inflation expectations. In China, lockdowns and financial stress have eased a tad but continue to be a risk to global macro.

Broad USD strength as stagflation returns as a market theme

Over the past month, broad central bank repricing, commodity prices and widening credit spreads have been key drivers in FX markets. There has been a broad sell-off in commodity currencies such as NOK and AUD. SEK also sold off amid global growth slowing and poor risk sentiment. Central banks are still communicating that more tightening is in store. For example, Italian yields have risen so much that ECB held an emergency meeting to discuss possible measures to allow for stability in spreads while raising interest rates in the coming year. USD has been the clear winner (supported as a ‘safe haven’ and due to the large energy sector) with USD strength broadening, also versus SEK and NOK.

Generally, our forecasts are largely unchanged as we continue to expect a stronger USD and elevated levels in EUR/Scandies. The JPY weakness has been noticeable. In the short run, the global pressure for higher yields and the global energy crunch will keep weighing on JPY but the risk of Tokyo intervening has increased significantly over the recent weeks. Looking ahead, we expect a mild JPY strength over the coming 12m.

A key assumption behind our FX forecasts is that of a stronger USD and tightening of global financial conditions. Risks to this assumption include global inflation pressures fading fast, renewed focus on China easing, a global capex uptick and/or industrial production increasing, which could underpin a new reflation leg higher.

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