Evergrande's fate remains uncertain, but markets are now less concerned about any potential systemic impact, leaving room for risk assets to rally. Improved sentiment has weighed on the dollar, which is also discounting markets' reluctance to align with the Fed's Dot Plot. Today, we'll keep an eye on the German IFO, as well as Fed and ECB speakers.
USD: Lower than it should be?
A week that started with serious concerns around the impact of a potential Evergrande default is ending with a broad-based rally in equities, as well as in most pro-cyclical currencies. That does not appear to be strictly a result of markets pricing out the risk of an Evergrande default, but mostly of markets pricing out the systemic effect that the default may cause. Despite being still unclear as to whether China will offer direct support to the company to mitigate solvency issues, the PBOC has been particularly active in pumping extra cash into the system to avert a liquidity crunch. Over the past few days, investors have also had the chance to establish that there is no material direct exposure of Western banks to Evergrande’s debt crisis. That said, markets may have rushed too much to downplay the impact of a potential Evergrande default, and risks are that we may see more corrections in the coming days, depending on how the company’s situation evolves.
In FX, it is no surprise that the dollar has seen its upside capped as risk sentiment has improved. What appears more surprising is how the dollar struggled to find any kind of support on the back of the more hawkish than expected FOMC announcement on Wednesday. Market reluctance to “trust” the new Fed Dot Plot seems to be the main cause here, as the OIS curve has remained well below the projected rate path after the meeting. This could remain the case until investors get a chance to see more hard data out of the US, but we are still inclined to think markets will buy the dips in the dollar given the reinforced backdrop of policy normalisation in the US.
Today is a very quiet day data-wise, with only housing data set to be released in the US. However, it will be a very busy one in terms of Fed speakers, as Powell, Clarida, Mester, George and Bostic are all set to speak at different events. While they may not add much to the recently updated policy message, it will be interesting to see whether they re-emphasize the role of jobs data and possibly provide further details about the ongoing tapering discussion.
EUR: Focus on IFO, Lane and German vote
A week full of events failed to generate any clear directional move in EUR/USD, which is back around in the 1.1700/1.1750 range level after some dollar weakness yesterday offered support to the pair. Following a below-consensus set of PMIs yesterday in the eurozone, today’s German IFO sentiment indices will provide extra indications about the area’s sentiment as businesses faced a combination of Delta variant concerns and lingering supply disruptions.
Weak PMIs yesterday failed to dampen the EUR, and we doubt today’s IFO will have a major FX impact. Instead, investors may look with more interest at the scheduled remarks by ECB Chief Economist Philip Lane this afternoon, especially after the Estonian Governing Council member Madis Muller hinted at the possibility of raising the APP once the PEPP ends earlier this week.
Still, barring any particularly surprising policy-related comments, EUR/USD may find stabilization in a tight range (1.1710/1.1760) into the weekend, which sees Germans heading to the polls. Yesterday, the final television debate saw both front-runners (SPD’s Olaf Scholz and CDU/CSU candidate Armin Laschet) voicing quite similar views on many key topics, as they both stressed the need to strengthen the EU’s international role. The two candidates are nearly tied in the race at the moment, with Scholz leading by 2% in the latest opinion polls. This seems to suggest the outcome of the Federal vote may be an extended period of coalition negotiations, and any impact on the EUR may be not become evident already next week.
GBP: Markets may have got ahead of themselves with BoE pricing
The pound recovered nearly all of this week's losses yesterday after the Bank of England surprised on the hawkish side as: a) policymakers acknowledged that some recent developments have strengthened the case for “moderate tightening”; b) they now see inflation peaking above 4%; c) two members voted against keeping the bond-buying target unchanged. The result has been an increase in speculation for earlier tightening, with a 15bp rate hike in February 2022 now almost fully priced in.
However, as discussed by our economist here, the MPC still appears divided around the actual threat posed by higher inflation, and considering the number of potential headwinds the UK economy is set to face in the coming months (not least, the end of the furlough scheme), we think it is too premature to expect a rate hike before mid-2022. Accordingly, we doubt GBP will be able to benefit from further sustained hawkish re-pricing in the remained of the year.
However, as it appeared that GBP over-discounted the risk-off environment at the start of the week, we could see the currency staying supported into the weekend as higher BoE rate expectations offer a positive underlying narrative in a day without data releases worth highlighting in the UK.
NOK: Buoyed by the Norges Bank's hawkishness
The Norwegian krone is the best G10 performer this week. In terms of external drivers, NOK has benefitted from having the highest beta to risk sentiment in G10 (which has strongly recovered after Monday’s sell-off) and also the highest beta to oil prices (yesterday, Brent futures settled at the highest since October 2018).
On the domestic side, yesterday’s Norges Bank rate announcement offered extra support to the currency (as discussed in our meeting review). While a rate hike was fully priced in, the Bank reinforced their tightening plans by signalling one more hike will come in December and upgrading their longer-term rate-path projections. This is, in turn, cementing the view that NOK will have the most attractive G10 yield (along with NOK) starting from late this year. We think this will ultimately keep pressuring EUR/NOK in the coming months, and we expect EUR/NOK to trade sustainably below 10.00 in the first half of 2022.
Read the original analysis: FX daily: Some key takeaways from a very eventful week
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