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Narrow Ranges in FX: Calm before the Storm?

Narrow Ranges in FX:  Calm before the Storm?

Overview: Equity markets are mostly weaker, and benchmark 10-year yields are a little softer. The foreign exchange market is subdued ahead of today’s US CPI. The large bourses in Asia Pacific region with the exception of India worked lower and Europe’s Stoxx 600 is off for the second consecutive session. US futures have a heavier bias. Yesterday the US bank share indices filled the gap created at the end of last week but recovered. Today’s price action will be important from a technical perspective. Benchmark 10-year yields in the US and Europe are mostly around two basis points lower, which leaves the 10-year Treasury yield near 3.50%.

The dollar has been confined to narrow ranges against the G10 currencies. The derivatives markets have begun pricing in a small chance of a hike (~15%). Leaving aside the Norwegian krone, the greenback is +/- 0.1% against the major currencies. Emerging market currencies are mixed, but we note that the Mexican peso has made a marginal new six-year high. Gold is trading quietly in about a $6 range on either side of $2032 as in consolidates. June WTI stalled after reaching nearly $73.80 yesterday. It is near $72.45 as it too consolidates its recovery from last week’s low near $63.65. 

Asia Pacific

The rapprochement between Japan and South Korea may be among the most important diplomatic developments this year. This is seems to be one of the unforeseen indirect consequences of Russia's invasion of Ukraine, heightened sensitivity to similarities with Taiwan. Beijing may be its own worst enemy here too, as its bullying in the region is forcing new alliances. This is the same strategic error the US is accused of by fostering a stronger alliance among its adversaries (China and Russia). Henry Kissinger recently opined that Russia-Ukraine war is entering a new phase. He expected "actual negotiations" to begin later this year, with China's help. 

Russia invaded Georgia in 2008, and outside of some sanctions and chin-wagging, little changed. Russia took Crimea in 2014, and again some sanctions and chin-wagging but little changed. Putin went to the "cookie jar" a third time in 2022 and this time it produced a reaction that likely surprised western leaders as much as Putin. With money, aid, and intelligence, the US turned it into a proxy war, of sorts. Although Ukraine was part of the Soviet Union, it is now claimed that the future of western democracy depends on Ukraine's territorial integrity. China sees this as a potential trap for the west, in general and the US in particular. The harm done to China's strategic interests by Russia's invasion of Ukraine cannot be undone, but Beijing can try to secure advantage elsewhere and it is not clear that keeping the west heavily invested in the war in Ukraine does not serve it purposes. Moreover, Ukraine-fatigue seems to be setting and there is serious risk that the US election next year, for example, could result in less money and aid for Ukraine. To China, this may be a preferable outcome than a negotiated settlement. 

The dollar continues to be mired in a narrow range against the Japanese yen. Ahead of the US CPI, the greenback is in less than a half of a yen range below JPY135.50. It did make a marginal new five-day high slightly below JPY135.50 today. It is the fourth consecutive session of higher lows, and so far, it is holding above JPY135.00, which if sustained would be the first time in two months. Below there, nearby support is seen in the JPY134.60-70 area. Australia's budget was in line with previous press reports and the Australian dollar seemed unaffected. It was turned back from the upper end of its three-month trading range near $0.6800 on Monday and is hovering near yesterday's low slightly below $0.6750. Support may be around Monday's low (~$0.6725) and then $0.6700, the middle of the well-worn range. The greenback ground slightly higher against the Chinese yuan to trade above CNY6.93 for the first time since last April. It is holding above CNY6.92 for the first time in two months. The PBOC set the dollar's reference rate at CNY6.9299, tight to the median in Bloomberg's survey of CNY6.9296. 


The European economic calendar is light, and the focus is on tomorrow's Bank of England meeting. The market has little doubt that the BOE will deliver another rate hike and lift the base rate to 4.50%. The swaps market sees the terminal rate between 4.75% and 5.0%, with a bias toward the latter. The Bank of England was among the first to raise rates in this cycle, with a small hike delivered in December 2021. Ahead of this week's meeting, it has hiked by a cumulative 415 bp. Yet, its inflation remains stubbornly high. Headline CPI peaked in October at 11.1%, but through March it has remained above 10%. Still, a sharp fall is expected when the April figures are reported on May 24, as the April 2022 2.4% surge drops out of the year-over-year comparison.

There has been further confirmation that Italy will exit China's Belt Road Initiative. It is the only G7 and NATO member to have joined, and apparently sidelined in some diplomatic circles since joining. Prime Minister Meloni reportedly told US House of Representative Speaker McCarthy that is the government's leaning ahead of a formal decision expected before the end of the month. Under former Prime Minister Conte, Italy joined the BRI in 2019. In the absence of a formal decision to leave, Italy's membership in the BRI would automatically be renewed next year. Of course, the US is pressing Italy to break from the BRI, but Rome has its own pressures too. A decision is also expected about Sinochem, which is the largest shareholder of Pirelli, Italy's large tire company, with a 37% stake. Last month, Pirelli announced it was postponing its annual shareholder meeting until late June due to Rome's review of governance agreement with Sinochem.

The euro settled below its 20-day moving average yesterday for the first time since March 16. Even though there has not been follow-through euro selling today, and the $1.0940 level is holding, the five-day moving average (~$1.0990) is slipping through the 20-day moving average (~$1.0997) for the first time since March 14. A break of $1.0940 signal a test on the $1.0875-$1.0900 area. That said, the intraday momentum is stretched, and initial resistance may be encountered near $1.0980. Note that tomorrow, options for 1.1 bln euros at $1.0925 expire. Sterling is trading in about a third-of-a-cent range today below $1.2645 and is hovering around little changed levels. It may continue to consolidate ahead of tomorrow BOE meeting. The underlying tone remains firm without the moving average violations and turns seen in the euro. Lastly, Poland's central bank is expected to remain on hold with its key rate at 6.75% today. 


Even though the debt ceiling and the elevated concerns about US regional banks continues to hang over the market, attention today turns to the April CPI. The year-over-year pace of inflation is moderating, and there is scope for further declines in here in the first half. In fact, by the end June, US year-over-year headline CPI could slip below 4% and the core rate could be below 5%. However, there are two problems on the horizon. First, a good part of the decline reflects the base effect, as last year's high numbers drop out of the 12-month comparison. That comparison is more difficult in the second half of the year. It is when CPI may prove stickier even if updated shelter costs are included. Second, assuming that the median forecasts for today's report are in line with expectations (0.4% headline and 0.3% core), the annualized pace through the first four months of the year will be around 5.2% and 5.8%, respectively. This is a challenge for the Fed, which continues push against expectations of rate cuts this year. The Fed funds futures imply a year-end effective rate of about 4.37%. The effective rate hovers closer to the lower end of the target rate (5.00%-5.25%) and has been averaging about 5.08% since last week's hike. Recall that before the bank stress erupted the market was leaning toward a 5.75% terminal rate.

The debt ceiling looms large. While many see this as another chapter in a familiar drama, some warning that the intransigence this time is different. The extreme pricing in the T-bill market as being consistent with a few days delay. The idea being bandied about by observers and investors is that it will take some kind of shock to motivate the politicians to reach a settlement. Short of a default, some observers suggest that a significant decline in equities could help facilitate an agreement. Recall that in 2011, the brinkmanship tactics were alone were sufficient to prompt S&P to cut the US rating. House of Representatives Speaker McCarthy ruled out a short-term extension, seemingly affirming through negation that it was being discussed, but the White House denied it and insisted on a clean bill. Still, the basis for an agreement is there:  A clean debt ceiling lift and a separate budget agreement (broad strokes) for the next fiscal year. 

The greenback is trading quietly in a CAD1.3370-CAD1.3400 range, just inside yesterday's range. It takes a break of the CAD1.3360 area to signal a retest on this week's low near CAD1.3315. On the upside a move above CAD1.3415 may signal a range extension toward CAD1.3450. Meanwhile, the US dollar has slipped to a marginal new multi-year low against the Mexican peso near MXN17.7350. The carry and low vol make it among the market favorites. Note that the lower Bollinger Band is near MXN17.74. Mexico's April CPI was in line with expectations and probably did not change anyone's mind about next week Banxico meeting. Some look for a pause in the tightening cycle with the overnight target rate at 11.25%.

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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