FX daily: Bessent provides more rationale for Yen intervention

Expectations of another ceasefire in the Gulf and lower oil prices have seen market rates drop and equities rally. A risk-on environment would normally see the dollar come lower, but uncertainty about Fed policy and a healthy US economy are keeping the dollar supported. US Treasury Secretary Scott Bessent has provided more colour on FX intervention.

USD: Dollar is holding up quite well

Financial markets are experiencing one of their periodic pro-risk turns. Reports suggest a new US-Iran ceasefire deal could be announced today, allowing traffic to transit the Strait of Hormuz for 60 days without a fee. Oil prices have been trading off that story all week, bringing Brent below $80/bl and delivering lower market interest rates and higher equity prices around the world.

The above dynamic would normally be associated with a weaker dollar, as investors put money to work outside the US. But that's not quite the case. DXY dollar index continues to trade near 100, which probably owes to lingering fears that the Fed might still hike on 16 September. Lower oil prices and perhaps some slightly softer JOLTS jobs data have seen pricing for that Fed move drop to +14bp from +16/17bp at the start of the week.

While Friday's US July jobs report is still the biggest macro driver this week, there will still be focus on today's ISM services release and the monthly ADP numbers. Regional surveys suggest the former should remain strong and an ADP release near consensus of +65k looks unlikely to hit the dollar too hard. Overall, we can probably see DXY trading in a tight 99.50-100.00 trading range today.

Elsewhere, Treasury Secretary Scott Bessent yesterday provided some colour to the recent participation in joint intervention on the yen. One of his points, which we did not cover in our review, was that yen weakness could trigger competitive devaluations in the region. This harks back to some of the hot topics in last year's Mar-a-Lago accord discussions, where undervalued Asian currencies were blamed for the hollowing out of the US manufacturing sector. His comments also seemed to imply a quid pro quo had been made with the Bank of Japan, where, in exchange for intervention, the BoJ would hike earlier than expected in September. Chances of an earlier BoJ hike have been marked sharply higher this week. USD/JPY may well have put in a significant top at 164, but cementing it will require both faster BoJ tightening and the Fed avoiding a hike.

EUR: Lacklustre

Despite better-than-expected hard eurozone data last week and a decent fall in energy prices this week, EUR/USD has struggled to make much headway on the upside. Perhaps that is a function of drought conditions in Europe and low water levels, which are hitting industrial river traffic. Nevertheless, as a pro-growth currency, the global equity rally and buoyant investment trends should be helping the euro. Here, a move through 1.1550/60 today could open up 1.1615/20.

There may also be a case for a slightly stronger Swedish krona right now. The krona had been punished for the Riksbank's dovishness in a world of higher interest rates. This week's drop in energy and rates could see EUR/SEK correcting back to the 10.90 area.

CZK: Lower inflation to ease CNB hike pricing

July inflation in the Czech Republic is due today, and we expect headline CPI to rise from 1.5% to 1.7% year-on-year, mainly on higher fuel prices. However, core inflation will remain the key focus, as it was one of the reasons behind the Czech National Bank's June rate hike. The flash estimate offers limited detail, and unless inflation delivers a significant surprise, the market impact should be limited given ongoing geopolitical developments and tomorrow’s CNB meeting, where a new forecast will also be presented.

Our forecast of 1.7% headline inflation and 2.8% core inflation should ease hawkish market expectations and soften the CNB’s hawkish rhetoric, which remains our baseline. The market is still pricing in two rate hikes, but unless inflation surprises to the upside, tomorrow’s CNB meeting should deliver a more dovish outcome than current pricing implies. Together with lower oil prices, this should lead the market to price out at least one hike. That should put some pressure on the koruna, which has recently underperformed its CEE peers for the reasons outlined above, and we expect this trend to continue as market pricing turns more dovish. This should keep EUR/CZK closer to 24.200.

BRL: Another 25bp rate cut expected from BACEN today

Brazil's central bank, BACEN, is widely expected to cut the policy rate by 25bp to 14.00% today. It feels that last year's 450bp rate hike to 15% did enough to slow inflation and is now unwinding that tightening. With Brazil's IPCA inflation running at 4.5% year-on-year, today's rate cut will still leave the real policy rate at a staggering 10% and will continue to encourage carry trade inflows into the Brazilian real.

Political risk in the form of Brazil's presidential election in October poses the biggest risk to the real. Neither candidate, President Lula nor Flavio Bolsonaro, seems serious about fiscal austerity. Yet investors are offered substantial compensation for holding the Brazilian real, and we expect it to continue outperforming the steep USD/BRL forward curve.

Read the original analysis here