A follow-up to last week's performance – Commerzbank

In the face of emerging global recession fears, not only have US interest rate expectations been corrected over the past week, but so have those for most of the other G10 countries. Correcting for these distortions, the market is now pricing in stronger rate cuts for all countries except Japan by the end of the year. Given that most central banks have only three meetings left this year, this is a remarkable development, Commerzbank’s FX strategist Michael Pfister notes.

Market prices in stronger rate cuts for all countries except Japan

“It seems that the extent to which the market was anticipating more rate cuts was less of a factor in last week's performance. Otherwise, the Norwegian krone, the Australian dollar and the kiwi would not have been among last week's worst performers. After all, only a few more basis points of rate cuts had been priced in, and expectations for the Norwegian krone remained virtually unchanged.”

“In times of heightened risk aversion, it is less important how many rate cuts the market expects from the respective central bank. Rather, how much can the central bank cut rates if we really get into a global crisis? If we visualise this potential and compare it with last week's performance, this relationship becomes clear. Although there are outliers, currencies performed better last week when the potential for rate cuts was lower.”

“This does not bode well for central banks, which continue to sound hawkish in the face of persistent inflationary pressures (Norway, Australia and New Zealand). After all, a weaker currency tends to exacerbate imported inflationary pressures, exacerbating the problems of smaller economies in particular. So, these central banks are likely to be less happy about the latest development, even if there is nothing they can do about it.”