Sentiment started the session strong on the back of a mortgage rate cut in China over the weekend and signs of an easing of its Covid lockdowns in Shanghai. But the investor mood turned sour following the downside surprises in the China cyclical data. At the time of writing, S&P500 futures and a modest majority of Asian bourses were trading lower. The weak China data led to the Antipodeans being the underperformers in the G10 in the Asian session and the JPY was the outperformer.
USD: the chief propagator of Fed tightening around the world
There are many channels through which the Fed is tightening spreads around the world at present. They range from the higher costs of borrowing in USD to spikes in risk aversion which trigger portfolio outflows and increase the cost of funding of more vulnerable borrowers in their local currencies. The USD has become a very important propagator of Fed tightening in its own right. Indeed, the USD’s rapid ascent of late has forced a number of central banks to try to match the Fed’s tightening measures in order to stabilise their own currencies and thus prioritise financial stability over economic growth. The need for aggressive monetary tightening has been made more urgent by the fact that the USD strength coincided with very elevated commodity prices
JPY: having it both ways?
The JPY has received a burst of support from weakening risk sentiment as well as lower UST yields. Indeed, the return of UST yields and global equity markets moving in the same direction has also seen the return of the JPY’s usually strong negative correlation with global equity markets. Previously, higher UST yields and the Fed’s tightening was driving equities lower and leading to a muted response in the JPY as the currency was torn between being pulled lower by higher long-end UST yields and being supported by weaker equity markets. The JPY is now having it both ways as investors face the dual risk of the world’s two largest economies potentially sputtering – the US as the Fed hikes rates to control inflation and China due to its zero-Covid policy. This dual threat is driving long-end UST yields lower in line with equities. The JPY will continue to receive support until concerns on at least one of these dual fronts gives way.
EUR: can it avoid gassing out?
Heightened concerns over a potential cut to EU energy supply from Russia took its toll on the EUR, while this week and next could prove a watershed with regard to whether Russia would put its threats into action over gas payments. Any interruption to gas flows to the largest EU economies could indeed risk reviving recession fears in the area, while the European Commission is due to publish its latest economic forecasts this morning. Lower growth and higher inflation for this year are almost a given, while attention could ultimately focus more on how such bleak developments filter through to 2023. While clear evidence of stagflation risks in the Eurozone could indeed keep the EUR on the back foot, the media reports on the European Commission’s draft projections over the weekend may have reduce the scope for negative surprises today. Meanwhile, the EUR is unlikely to find any relief from the latest external trade data.