FX Market Briefing - 'Conflict' - October 16th

Last week

USD: The Greenback found support from stronger-than-expected CPI data and slightly more hawkish FOMC minutes (albeit it was discounted given the newly developed Fed language of risks being balanced). Geopolitics was pivotal with developments in the Middle East, the conflict led to flight-to-quality flows for gold as well as U.S. Treasuries, possibly affecting yields in the longer term. Fed officials were in sync stating the uptick in yields is doing the job for the Fed. Overall, the outlook for the USD remains generally strong, although it is sensitive to newly forming Federal Reserve language and developments in geopolitical risk.

CAD: The Loonie saw limited positive direction finding some support from rising oil and commodity prices, but rotation out of high beta and risk assets looked to be weighing interest later in the week. BoC's Macklem echoed the Fed's sentiment on yields, but added the battle is to reach a 2% inflation target. China's inflation data flatlined emphasizing its challenges in growth since reopening of economy last November.

EUR: EUR faced challenges with little positive news to bolster its strength. Firm USD could continue weigh, especially if tensions in the Middle East escalate further. Unless there is an easing of geopolitical tensions or unexpected turn into positive economic data from the Eurozone – expect directionally long EUR positions to face some turbulence.

GBP: GBP faced headwind due to weakness in the UK's GDP data. Other data, such as falling vehicle production and credit card usage, also suggests a lackluster outlook. Despite a bounce from 1.2000-2100 range against USD, Sterling's outlook remains vulnerable. Huw Pill, Bank of England Chief Economist, iterated that the BoE's rate decisions are finally balanced. This leaves UK exporters with some increased interest to hedge this Sterling rally for Q1 2024 sales, while at the same time considering USD potential seasonal weakness and needing to determine precise budget GBP denominated budget rates.

JPY: Strong U.S. data and rising yields are challenging the JPY, along with haven status weakening in recent years. With the absence of Bank of Japan intervention, nominal yield differentials continue to be the driver. JPY buyers should keep patience in their programs until a shift is more evident despite the historical USDJPY highs.

Week Ahead

USD: Upcoming USD performance hinges on Fed Chair Powell's speech this week, as well geo-political developments. A hawkish tone could lift the USD, despite low odds for a November rate hike. A dovish tone seems unlikely and would prompt early year end profit-taking on USD and treasuries. Retail sales, expected to rise 0.3%, are a secondary focus. Minor policy cues may come from speeches by Fed officials Williams, Harker, and Barkin. Geopolitical tensions in Israel and Gaza could bolster the USD's safe-haven status, particularly with potential Fed-FX swaps with the Bank of Israel. Traders should keep monitor on positions into Powell and retail sales for hedging adjustments. Corporate earnings will be in focus in parallel as they report in the midst of lower risk appetite.

CAD: A strong CAD CPI report may solidify minor gains made after BoC Gov. Macklem's hawkish comments last week. Strength in oil prices due to geopolitics could provide support, but lack of risk appetite has made the Loonie backdrop vulnerable. Though the 50 day moving average continues its steep rise, leaving Canadian exporters in a tight price window to assess hedging structures once/if spot starts turning below its time series averages. In tandem, importers may seek moderate opportunity hedging with USD expenses as spot relatively declines below cycle averages. The point of concern from both sides is the ultimate percentage figure of the hedge ratio for forward months.

AUD & NZD: AUD will be influenced by RBA meeting minutes and labor data. A sustained demand in commodities could lend support, however USD preference outweigh commodity fx trade. NZD has CPI data. A strong CPI could reinforce the RBNZ case for tightening, offering relative NZD uplift.

EUR: Eurozone faces inflation data week, with key focus on the Euro Area Inflation on Wednesday and ZEW surveys for economic sentiment on Tuesday. Polish elections are due over the weekend with some relative concern around a more conservative government winning the majority. Main concern is around a pattern . Geopolitical issues, could usher in risk aversion, affecting volatile European currencies. While it's unlikely, a less hawkish tone from Fed Chair Powell could cap USD strength, offering a respite to the EUR.

GBP: In the UK, anticipated softer inflation and labor data pose some downside risks to the GBP, potentially influencing EUR/GBP dynamics. The market currently gives a low probability to a November Bank of England rate hike, yet there's near 50% expectation for a year-end hike - though this has some overpriced characteristics, adding some near term downside risk to the GBP's moderate rise.

JPY: Geopolitics offer haven prospects towards JPY, which faces overstretched weakness. USD/JPY traders should be cautious around 150 ahead of Japan's September inflation data, with the BoJ lurking. Though sentiment currently outweighs real yield differentials and any haven scope. China will take some market attention with Q3 GDP data release with PBOC assessing new loan rates.

FX Risk Management Tip: We highlight the significance of Conflict Currency Risk for businesses operating internationally. Political instability, economic sanctions, capital flight, and supply chain disruptions can all lead to unpredictable currency fluctuations, with investments or with physical business operations. These shifts can impact performance, investment values, trade margins, and the ability to repatriate profits. Proactive measures like hedging, product assessment, diversification, and continuous monitoring of geopolitical events are essential tools for participants to manage these risks effectively.

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