FX daily: Low yielders set to remain under pressure

The defensive currencies – the Japanese yen and the Swiss franc – remain soft. That may be because equity markets remain reasonably bid despite the rise in energy prices. But a far more important factor appears to be low interest rates and central banks that will be slow to hike. Expect USD/JPY and USD/CHF to stay bid during this period of high energy prices.

USD: No respite from higher energy prices

The global investment environment can be characterised as one in which risk appetite remains reasonably strong, even as higher energy prices drive interest rates to new highs. The former is heavily predicated on the AI-investment boom continuing to deliver on its promise of future earnings. That thesis remains intact for the time being, and Alphabet's release of Q2 earnings after the bell today will provide fresh insights.

Given the quiet summer markets (the global calendar is exceptionally light today), investors continue to gravitate towards currencies that will deliver yield as well as offer some protection against even higher energy prices should the conflict broaden further in the Gulf. The dollar and the Norwegian krone remain the go-to currencies here, while the defensive low-yielders like the yen and Swiss franc remain offered. On the yen, the Bank of Japan's decision not to intervene during the recent public holiday has emboldened the market to take USD/JPY a little higher. This could grind towards the 164/165 area into next week ahead of the BoJ policy meeting on 31 July.

But USD/CHF rather than USD/JPY could become an increasingly popular vehicle for these summer months; the Swiss National Bank is not going to surprise with $70bn of FX intervention (as the BoJ did in April/May). In fact, the SNB probably welcomes this weaker Swiss franc. Here, it looks to be one of the last central banks to hike. And higher energy prices and higher rates in general deliver wider interest rate differentials against Swiss rates. We have been discussing a higher USD/CHF over recent weeks, and if energy prices have another leg higher, USD/CHF could deliver some powerful follow-through on a break of 0.8150/70 resistance.

DXY should stay supported in the middle of its 100.35 to 101.80 range, and we would continue to favour the upside over the short/near term.

EUR: Clinging on

EUR/USD has been performing relatively well despite the rebound in energy prices that has seen natural gas prices retesting the March highs of EUR60/MWh. Interest rate differentials have probably had a say here, with higher oil prices seeing investors price a more aggressive tightening response from the European Central Bank than the Federal Reserve. However, as our team points out in their ECB cheat sheet, it is hard to see the market pricing in even higher ECB rates, regardless of the language delivered at tomorrow's ECB meeting and press conference.

Barring a near-term move towards another cease-fire between the US and Iran, our bias remains for EUR/USD to drift back to 1.1380 and then take its cue from tomorrow's ECB meeting.

GBP: Inflation heading in the right direction

Despite the slightly higher-than-expected UK June core inflation data this morning, ING's UK economist, James Smith, thinks the underlying trend is heading in the right direction. Here is what he says:

"Firstly, headline inflation fell more than expected on a second-consecutive monthly fall in food prices. This basically never happened – and wasn't what was supposed to happen after the Iran war. Yes, the impact on food inflation will take several months to come through in full, but for the Bank of England hawks who worry about the salience of food and petrol prices for consumer inflation expectations, the fact you have both falling in outright terms between May and June is welcome news. Then on services, when we calculate the BoE's preferred 'core services' metric excluding volatile and indexed categories, that fell more sharply than overall services inflation – from 3.8% to 3.6%. The trend looks good, and together with low private-sector wage growth, suggests domestically-generated inflation is benign right now."

Sterling is a little weaker on the data and EUR/GBP may well have put in a significant low at 0.8455 last week. Please look out for a more detailed EUR/GBP article later today.

HUF: NBH keeps cuts on track

The National Bank of Hungary, as expected, cut rates by 25bp to 5.75% and confirmed its dovish forward guidance. It committed to another rate cut in August and an assessment of the situation in September, possibly continuing the cutting cycle from there.

The NBH’s confirmation of its earlier forward guidance, despite elevated volatility and pressure on Hungarian assets amid the global risk-off sentiment, should reassure markets that the local story is unchanged. The reaction after the press conference suggests investors have accepted the dovish signal, with rate cuts returning to market pricing. We expect this to continue, supported by an unchanged fundamental backdrop after the April elections and repeated downside inflation surprises. With markets having priced out around 40bp of easing and the implied terminal rate back near 4.75-5.00%, we expect pricing to shift toward a more dovish view after yesterday's meeting, closer to our medium-term forecast of 4.00%, while curve steepening continues.

This remains highly dependent on the global backdrop, where visibility is limited. However, any global relief should deliver the strongest gains in the HUF market, in our view, as Hungarian rates led the EM sell-off and the central bank has just confirmed that the domestic policy story remains unchanged.

The FX implications are more mixed. Further NBH rate cuts would weaken expected carry, while a stronger US dollar and risk-off conditions remain unfavourable for EM currencies. Still, EUR/HUF has almost returned to post-election levels, which should limit further upside. If the global backdrop stabilises, we expect EUR/HUF to move back below 360.

Read the original analysis here