Recent developments: more hawkish Fed and lower energy prices
- Since our last FX Forecast Update on 21 May, a resilient US labour market and signs of persistent underlying inflation have kept US monetary policy repricing at centre stage. At Kevin Warsh’s first meeting as Fed Chair, rates were left unchanged, though the accompanying dot plot and communication revealed a shift toward a hiking bias, which in turn led to a repricing of USD rates. As expected, the ECB delivered a 25bp hike citing increased inflationary concerns, although economic data have surprised to the downside in the past months. The preliminary US-Iran agreement has pulled oil prices down to around USD80/bbl, though the otherwise muted market reaction extends the pattern of fading FX sensitivity to the Iran war. Against this backdrop, risk appetite has been mixed, caught between the headwinds of a hawkish Fed repricing and a resilient equity market, where a strong rebound in tech stocks has brought global indices back close to new highs.
FX implications: continued dollar strength and headwinds for Scandies
- Over the past month, the dollar has continued to strengthen against the backdrop of a Fed tightening bias, pushing EUR/USD down below the 1.15 mark. Overall FX market developments have remained relatively muted. The retreat in energy prices has turned into a headwind for energy-exporting economies, reversing the last months’ tailwind, leaving NOK, CAD and AUD as the relative underperformers in G10. Noteworthy, the SEK has also had a bad month, despite the drop in energy prices, which reflects the general overperformance of Swedish fixed income. EUR/DKK has moved higher to new highs, returning focus to Danmark Nationalbank’s reaction function on FX intervention. USD/JPY has been gravitating around the 160 level, with a strong USD supporting the cross despite the BoJ’s 25bp hike to 1.00%.
Outlook: continue to be bearish on EUR/USD and bullish on EUR/Scandies
- Given the recent move lower in EUR/USD, we extend last month’s forecast on the 1-6M horizon, expecting the cross at 1.13 in 6 months, while we keep our 12M expectations at 1.12. For EUR/SEK, we leave our forecast profile unchanged as the risk of heightened inflation continue to weigh, expecting the cross to trade around the 11.00 on the 6M and 11.20 on the 12M-horizon. For EUR/NOK we have outcome-adjusted our profile slightly upwards on the back of the recent NOK weakening, driven by a tightening of short-end rates spreads to EUR, and now target the cross at 11.80 in 12M.
Key risk to our forecasts: geopolitics and the US monetary policy outlook
- Near-term risks are closely tied to the war in Iran, while medium- to long-term risks continue to be tied to the US growth outlook and the US monetary policy outlook. A much firmer focus by the Warsh-led Fed on bringing down nominal pressures in the US economy, could result in a considerably stronger USD and weaker Scandies than what we pencil in. Additionally, should the US economy prove less resilient than what we forecast, fears of a US recession could weigh heavily on the USD, with CHF, JPY and EUR likely proving the biggest beneficiaries in such a scenario. For EUR, a more prolonged ECB hiking cycle, potentially driven by fiscal easing or a more resilient euro area economy, could also cap USD strength. Finally, we will closely monitor uncertainty related to AI and broader signs of a turning global cycle.
