Morning Commentary: Shifting Focus From Rates to Risk
A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.
Shifting Focus From Rates to Risk
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Andrew Kositkun Senior FX Advisor
Risk markets have taken a hit, with market attention shifting to growth concerns stemming from another surge in infections. Renewed uncertainty, soft equity and commodity prices, and elevated rate volatility are all factors in a pullback in risk appetite, with quarter-end considerations exacerbating these moves. As a result, the U.S. dollar continues to strengthen, with low-growth, low-yield currencies leading the losses and higher-growth, higher-yield currencies also weakening against the dollar but to a lesser extent.
Conversely, easing concerns around early central bank rate normalization should provide support for risk assets. The Federal Reserve has reinforced its forward guidance and highlighted how decisions on tapering and hikes will be predicated on hard evidence rather than forecasts. The European Central Bank has also surprised to the dovish side, and changes from the Bank of Japan only further support the bank’s dovish stance. Broadly speaking, other central banks have also confirmed that the bar for rate normalization remains high and data dependent. This should keep short-term rates low, although upward pressure on longer-term yields should continue.
Given this, it is becoming increasingly difficult to find upside growth surprises, especially after recent forecast upgrades. Recent expectations for a synchronized recovery are being put to the test by rising infections. Data shows that the U.S. and Asia remain relatively insulated from this latest COVID-19 wave, with Europe, Latin America, the Middle East and Africa more impacted. This has led to tighter restrictions in areas such as Europe, which should weigh on economic activity. Further, divergence in monetary and fiscal trajectories should lead to material dispersions in economic and asset market performance, especially over the short term. This dynamic underscores why upcoming data will be important to watch.
Thus far, data points to a continued recovery. U.K. and euro area PMI numbers exceeded expectations, but the timing of the PMI survey means they do not reflect the recent tightening measures, leading to significant risks that euro area PMIs get revised down. China releases its PMIs later this week and should show a continued rebound in manufacturing, while Japanese data is also expected to improve, albeit with continued divergence between manufacturing and services due to state-of-emergency measures in effect at the time of the survey. Of course, the U.S. nonfarm payroll jobs report this Friday is always important and is expected to show a gain of 650,000 jobs as vaccination progress aids a pickup in hiring.
Beyond data releases is the OPEC+ meeting that should be an important driver for oil commodity currencies. OPEC+ ministers will be meeting to set production targets for May and possibly beyond. With COVID-19 cases increasing in Europe, Brazil and India, among other places, it’s possible the ministers take a more prudent approach and add a smaller increase than what was seen in January.
Overall, the U.S. dollar remains best positioned to benefit from the current environment, as it benefits from the best of both worlds. The U.S. has G-10–leading growth while also benefiting from safe haven qualities during market risk-off episodes. Conversely, the euro is expected to underperform other G-10 currencies due to its sluggish recovery and the COVID-19 situation. As for emerging markets, the strong U.S. growth backdrop should be positive for cyclically sensitive emerging market currencies, with some differentiation based on country-specific factors.
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