EUR USD - FUNDAMENTAL DRIVERS
EUR
FUNDAMENTAL OUTLOOK: NEUTRAL
BASELINE
The EUR has had a bumpy ride over the past few months. At the onset of the war in Ukraine the EUR tumbled across the board. However, in recent weeks, the persistently high inflation has seen the ECB take a more hawkish turn with the bank confirming at least a 25bsp hike for July and possibility of a 50bsp hikes in September. Despite the hawkish policy shift, the concerns over fragmentation in bond spreads like the BTP\Bund spread as well as fears of growing stagflation risks has seen the EUR struggled to hold onto any real momentum. The ECB did try to comfort spread concerns this past week with an ad-hoc meeting and decided to use PEPP reinvestments as a way to calm fragmentation. This was not enough to calm concerns though as reinvestment would amount to only 20 billion Euros per month. However, the bank’s decision was enough to push the BTP\Bund down 50bsp, and if that trend continues lower should be supportive for the EUR. The bank did back up their attempts at calming fragmentation fears after their ad-hoc meeting by saying they are looking at introducing an additional ‘tool’ as quick as possible, so markets will be focused on any insights into what that might be.
POSSIBLE BULLISH SURPRISES
Geopolitics remains a focus for the EUR, where any possible de-escalation or cease fire in the Ukraine war would open up a lot of appreciation for the EUR. Stagflation fears are high right now for the Eurozone, with growth expected to slow while inflation stays persistently high. However, a lot of bad news has already been priced in for the EUR, which means any materially better-than-expected growth data could spark some upside for the single currency. ECB Lagarde testifies before the EU’s Committee on Economic and Monetary Affairs this upcoming week. If Lagarde talks up even more aggressive policy or offers enough conviction that they will handle any spikes in BTP\Bund spreads could trigger some bullish reactions in the EUR.
POSSIBLE BEARISH SURPRISES
Fragmentation risks in spreads will remain a hot topic next week, and if ECB’s Lagarde fails to calm market’s fears or if she walks back on some of the hawkish takes for rates following their recent meeting (to help spreads) it could trigger bearish reactions in the EUR. Just like the EUR’s weighting in the DXY is an upside risk for the currency, the weighting is also a potential downside risk. Any potential catalysts that spark short-term upside in the Dollar (upside in yields, risk off sentiment, very hawkish rhetoric from Fed officials) can trigger upside in the USD and weigh on EUR. As growth is a concern in the Eurozone the incoming flash PMIs will be watched closely, and any bigger-than-expected contraction in PMIs could trigger bearish reactions in the EUR.
BIGGER PICTURE
The fundamental outlook for the EUR remains neutral right now as we have positive and negative forces impacting the currency. On the negative side we have geopolitics, stagflation and spread fragmentation acting as negative drivers. But we also have hawkish ECB policy and better-than-expected recent growth data as supportive drivers. Thus, the best course of action with the EUR right now is taking short-term plays which are driven by clear short-term bearish or bullish catalysts.
USD
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
Hawkish Fed policy remains a key driver for Dollar strength. With headline inflation >8%, the Fed has been pressured to tighten policy aggressively, hiking rates by 75bsp at their June meeting, and continuing with Quantitative Tightening. STIR markets suggests aggressive policy action pricing a terminal rate of >3.8% by 2Q23 which should be a positive input for the US Dollar . Safe haven flows have also supported the USD as it’s usually inversely correlated to the global economy and global trade, appreciating when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Expectations of a cyclical slowdown, accompanied by multi-decade high inflation and synchronized removal of monetary policy stimulus from major economies has seen investors shun risk assets and even bonds (usually considered a safe haven), and the USD has been a key benefactor of the rush to safety as economic prospects have deteriorated. Even though US bonds are considered safe havens, the current high inflation has seen a strong stock-to-bond correlation and has caused big bond outflows. With bonds not fulfilling its usual save haven role the USD has benefited from the rush to safety.
POSSIBLE BULLISH SURPRISES
As aggressive Fed policy has been supporting the USD, any incoming data (especially inflation ) that sparks further hike expectations, or additionally any comments from FOMC members that signals even more aggressive policy could trigger bullish reactions in the USD. As the cyclical outlook for the global economy is very bleak, and the USD is considered a safe haven, it means any incoming data that exacerbates fears of recession and triggers a big rush to safety could trigger bullish USD reactions. Further outflows in US bonds means more USD safe haven appeal. So, watching key triggers for further upside in bond yields like rising commodity prices and inflation expectations could also trigger further USD bullish reactions.
POSSIBLE BEARISH SURPRISES
More recently the USD has reacted more cyclically to incoming data which could suggest markets is shifting from safe haven focus to the rising risks of recession. The worse growth data slows, the higher likelihood of a ‘Fed Put’ in the months ahead. Thus, extremely bad growth data could trigger bearish reactions in the USD despite its safe haven appeal. Tactically the USD is trading at cycle highs, and aggregate CFTC positioning is still close prior highs which acted aslocal tops for the USD. Thus, stretched positioning could make the USD vulnerable to mean reversion in the short-term. With a lot already priced for the Fed, it won’t take much for the Fed to disappoint markets on the dovish side. Thus, any FOMC comments that suggests more concern about the economy than inflation could trigger bearish reactions in the USD
BIGGER PICTURE
The fundamental outlook for the USD remains bullish as long as the Fed stays aggressive and cyclical concerns put pressure on risk assets. But we do want to be mindful that lots has been priced for the USD, and growth deteriorates, we are expecting that the weigh on the USD if markets start pricing in a higher likelihood of a less hawkish Fed as a result of higher risks of recession. Furthermore, given tactical and CFTC positioning, we would prefer deeper pullbacks for new med-term USD longs, but shortterm catalyst can still offer shorter bearish sentiment trades against the current strong bull trend.
FUNDAMENTAL OUTLOOK: NEUTRAL
BASELINE
The EUR has had a bumpy ride over the past few months. At the onset of the war in Ukraine the EUR tumbled across the board. However, in recent weeks, the persistently high inflation has seen the ECB take a more hawkish turn with the bank confirming at least a 25bsp hike for July and possibility of a 50bsp hikes in September. Despite the hawkish policy shift, the concerns over fragmentation in bond spreads like the BTP\Bund spread as well as fears of growing stagflation risks has seen the EUR struggled to hold onto any real momentum. The ECB did try to comfort spread concerns this past week with an ad-hoc meeting and decided to use PEPP reinvestments as a way to calm fragmentation. This was not enough to calm concerns though as reinvestment would amount to only 20 billion Euros per month. However, the bank’s decision was enough to push the BTP\Bund down 50bsp, and if that trend continues lower should be supportive for the EUR. The bank did back up their attempts at calming fragmentation fears after their ad-hoc meeting by saying they are looking at introducing an additional ‘tool’ as quick as possible, so markets will be focused on any insights into what that might be.
POSSIBLE BULLISH SURPRISES
Geopolitics remains a focus for the EUR, where any possible de-escalation or cease fire in the Ukraine war would open up a lot of appreciation for the EUR. Stagflation fears are high right now for the Eurozone, with growth expected to slow while inflation stays persistently high. However, a lot of bad news has already been priced in for the EUR, which means any materially better-than-expected growth data could spark some upside for the single currency. ECB Lagarde testifies before the EU’s Committee on Economic and Monetary Affairs this upcoming week. If Lagarde talks up even more aggressive policy or offers enough conviction that they will handle any spikes in BTP\Bund spreads could trigger some bullish reactions in the EUR.
POSSIBLE BEARISH SURPRISES
Fragmentation risks in spreads will remain a hot topic next week, and if ECB’s Lagarde fails to calm market’s fears or if she walks back on some of the hawkish takes for rates following their recent meeting (to help spreads) it could trigger bearish reactions in the EUR. Just like the EUR’s weighting in the DXY is an upside risk for the currency, the weighting is also a potential downside risk. Any potential catalysts that spark short-term upside in the Dollar (upside in yields, risk off sentiment, very hawkish rhetoric from Fed officials) can trigger upside in the USD and weigh on EUR. As growth is a concern in the Eurozone the incoming flash PMIs will be watched closely, and any bigger-than-expected contraction in PMIs could trigger bearish reactions in the EUR.
BIGGER PICTURE
The fundamental outlook for the EUR remains neutral right now as we have positive and negative forces impacting the currency. On the negative side we have geopolitics, stagflation and spread fragmentation acting as negative drivers. But we also have hawkish ECB policy and better-than-expected recent growth data as supportive drivers. Thus, the best course of action with the EUR right now is taking short-term plays which are driven by clear short-term bearish or bullish catalysts.
USD
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
Hawkish Fed policy remains a key driver for Dollar strength. With headline inflation >8%, the Fed has been pressured to tighten policy aggressively, hiking rates by 75bsp at their June meeting, and continuing with Quantitative Tightening. STIR markets suggests aggressive policy action pricing a terminal rate of >3.8% by 2Q23 which should be a positive input for the US Dollar . Safe haven flows have also supported the USD as it’s usually inversely correlated to the global economy and global trade, appreciating when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Expectations of a cyclical slowdown, accompanied by multi-decade high inflation and synchronized removal of monetary policy stimulus from major economies has seen investors shun risk assets and even bonds (usually considered a safe haven), and the USD has been a key benefactor of the rush to safety as economic prospects have deteriorated. Even though US bonds are considered safe havens, the current high inflation has seen a strong stock-to-bond correlation and has caused big bond outflows. With bonds not fulfilling its usual save haven role the USD has benefited from the rush to safety.
POSSIBLE BULLISH SURPRISES
As aggressive Fed policy has been supporting the USD, any incoming data (especially inflation ) that sparks further hike expectations, or additionally any comments from FOMC members that signals even more aggressive policy could trigger bullish reactions in the USD. As the cyclical outlook for the global economy is very bleak, and the USD is considered a safe haven, it means any incoming data that exacerbates fears of recession and triggers a big rush to safety could trigger bullish USD reactions. Further outflows in US bonds means more USD safe haven appeal. So, watching key triggers for further upside in bond yields like rising commodity prices and inflation expectations could also trigger further USD bullish reactions.
POSSIBLE BEARISH SURPRISES
More recently the USD has reacted more cyclically to incoming data which could suggest markets is shifting from safe haven focus to the rising risks of recession. The worse growth data slows, the higher likelihood of a ‘Fed Put’ in the months ahead. Thus, extremely bad growth data could trigger bearish reactions in the USD despite its safe haven appeal. Tactically the USD is trading at cycle highs, and aggregate CFTC positioning is still close prior highs which acted aslocal tops for the USD. Thus, stretched positioning could make the USD vulnerable to mean reversion in the short-term. With a lot already priced for the Fed, it won’t take much for the Fed to disappoint markets on the dovish side. Thus, any FOMC comments that suggests more concern about the economy than inflation could trigger bearish reactions in the USD
BIGGER PICTURE
The fundamental outlook for the USD remains bullish as long as the Fed stays aggressive and cyclical concerns put pressure on risk assets. But we do want to be mindful that lots has been priced for the USD, and growth deteriorates, we are expecting that the weigh on the USD if markets start pricing in a higher likelihood of a less hawkish Fed as a result of higher risks of recession. Furthermore, given tactical and CFTC positioning, we would prefer deeper pullbacks for new med-term USD longs, but shortterm catalyst can still offer shorter bearish sentiment trades against the current strong bull trend.
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