Welcome to Forex Friday, a weekly report in which we discuss selected currency themes mainly from a macro viewpoint, but we also throw in a pinch of technical analysis here and there.
In this week’s edition, we discuss the big drop in bond yields, and its impact on the financial markets. We also look ahead to a few macro events in the week ahead.
Bond yields sink
The biggest eye-catching move this week was not the sell-off in stocks, or gold, or the rally in the dollar. It was the bond markets. Treasury yields sank as investors piled back into government debt and out of equities and high-beta foreign currencies:
This supported lowest-yielding currency: the Japanese yen. The USD/JPY and EUR/JPY all dropped sharply. It was a proper risk off environment. Essentially, it was recessionary worries intensifying while inflationary worries were fading.
Bond markets basically signalled that the Fed is going to be done with rate hikes sooner than expected. In other words, bond investors were signalling that peak inflation has been reached. But with stocks also selling off, equity investors seemed increasingly worried about economic growth.
How low will EURO go?
The euro had a week to forget as rates tumbled to below 1.04 handle. We saw further weakness in data while inflation hit a new record high of 8.6% in June. In recent weeks, we have seen consumer, business and investor sentiment all drop alarmingly. Stagflation is the key risk facing the Eurozone, which means the euro is going struggle to shine much even as the ECB has paved the way for aggressive 75 basis point rate hikes in July and September. Additionally, the fact that inflation has been diverging across the eurozone means the ECB will have a tough time with its anti-fragmentation tool and may make a bigger mess out of the whole situation. Against this backdrop, and given tensions related to the war in Ukraine and now NATO's expansion, it makes it a difficult environment for investors to confidently invest in the Eurozone. With the 1.04 handle broken, you would feel that the EUR/USD is now almost certain to drop to new lows for the year, after a very poor performance in the first half of 2022.
Looking ahead to the week ahead
Looking ahead to the first full week of July and third quarter, there are a few macro events to keep a close eye on.
The Reserve Bank of Australia is expected on Tuesday to hike interest rates by 50 basis points to 1.35% from 0.85% as it battles high inflation, like all other central banks. At its last two meetings, the RBA surprised the markets by hiking more than expected. Will it deliver another surprise? Actually, it might not, as the RBA governor explicitly said that it will either be 25 or 50 bps. The AUD could sink further in any event, should growth concerns intensify.
The FOMC’s meeting minutes will be in sharp focus on Wednesday as investors try and figure out exactly how hawkish each member is and how do they see interest rates evolving in the months ahead.
The on Friday, the US monthly nonfarm jobs report will put the dollar and gold into focus. The NFP is becoming less and less relevant for the markets as the focus has turned to inflation and economic growth than employment. Thus, the only thing that will matter from the jobs report is the wages bit. Workers will be demanding higher pay to keep up with inflation. Watch average earnings for upside surprises.
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