FX Talk - an Ebury podcast

Investors were caught wrong-footed by news of the full-scale invasion last Thursday, despite a host of warnings, with markets holding onto misplaced optimism that a peaceful solution could be found that would avoid conflict.

In FX, almost all emerging market currencies sold-off, most rather sharply, albeit there were some exceptions (notably those in Asia, including CNY). European currencies in general have underperformed, given their proximity to the conflict and close economic ties with Russia and Ukraine.

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Last week was a very eventful one of central bank announcements, with the Bank of England also holding its February monetary policy meeting on Thursday. As expected, interest rates were raised by a quarter of a percent to 0.5%, the first back to back rate increase in the UK since 2004, after rates were of course raised by 10 basis points back in December.

The euro has been one of the best performing G10 currencies in the past seven days, alongside the Swedish krona. The common currency rallied by more than one percent versus the US dollar last Thursday to back above the 1.14 level after ECB President Christine Lagarde struck a hawkish tone during the bank’s press conference. 

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So far in 2022, we have seen a broad rebound in most of these EM currencies, many in excess of 3% in less than 3 weeks - including the Brazilian real, South African rand and Hungarian forint. Now, while part of this recovery has to do with the broad weakness we’ve seen in the US dollar, we’ve also seen a general rebound in risk appetite, which has helped support these higher risk currencies.

The US dollar has depreciated against most of its peers so far this year. The dollar is currently trading as the worst performer in the G10 year-to-date, followed closely by the Australian and New Zealand dollars. 

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The main talking point in recent months has undoubtedly been the recent sharp increase in global inflation, driven largely by an unleashing of pent up demand and acute supply shortages. Price growth has continued to far exceed expectations of both central bankers and economists. Citibank’s G10 Inflation Surprise index, for instance, rose to a fresh record high in December. 

The detection and aggressive spread of the omicron variant of COVID-19 has triggered a few jitters among market participants. A number of countries, particularly in Europe, have tightened restrictions over the holiday period, which has raised a few concerns over global growth. The likes of Germany and Portugal have introduced post-Christmas curbs, while the Netherlands remains under a fairly strict lockdown. 

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We’re going to start by talking about the most traded and popular currency pair in the foreign exchange market, and that is of course EUR/USD, which has been on a rather volatile ride in the past fortnight. The cross began November around the 1.16 level, although it has since fallen sharply and is down about 3% month-to-date to below the 1.13 level and its weakest position since July 2020. 

As far as the euro is concerned, the common currency has been met with multiple headwinds. The European Central Bank has remained one of the more dovish central banks in the G10, while investors are growing concerned about the recent increase in virus caseloads in the bloc in the recent weeks.

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More than half of the major G10 central banks have announced their latest policy decisions in the past couple of weeks. The Bank of Canada abruptly ended its quantitative easing programme, much sooner than the market expected. The Reserve Bank of Australia held policy steady, although indicated that it could raise rates sooner than it had previously outlined. While Norges Bank indicated that it was on course for its second pandemic era rate increase at its December meeting.

We’re going to focus on the latest policy announcements from the European Central Bank, Federal Reserve, and Bank of England, which have all met since our last podcast episode.

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The main talking point in financial markets continues to be the sharp increase in inflationary pressures globally. This has caused investors to both fret that a slowdown in global growth could be on the cards in Q4, and also raised expectations for central bank interest rate hikes. 

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The Real remains one of the most volatile emerging market currencies that we cover, with levels of implied probability that exceed just about all of its regional peers. BRL sold-off aggressively at the start of the COVID-19 pandemic, falling to a record low of around 5.9 to the US dollar. The currency stabilized in the second half of last year and has largely held its own versus a broadly stronger dollar in most of 2021 so far.

It has, however, sold-off again in the past 3 months or so - down around 10% since the end of June. This makes the Real the worst performing currency in the EM spectrum during that time, despite the ongoing interest rate hike cycle from the Central Bank of Brazil - which has raised rates by 425 basis points since March. 

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Investors appear slightly torn between renewed optimism surrounding the pandemic and concerns surrounding the recent stagflation narrative, whereby many economic areas are seeing rising consumer prices, coupled with slower growth. Following the recent sharp increase in US inflation and robust labour market performance, investors have braced for an announcement that the Fed will soon begin tapering its large scale quantitative easing programme at some point this year. Also Germans will head to the polls on Sunday 26th September, and we’re set for a fairly significant political shift, because after 16 years in office, Chancellor Angela Merkel will be stepping down as Germany’s leader. 

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