Australian dollar bombed by Russia

DXY blasted off last night but couldn’t hold all gains:

Russia bombed the AUD but it bounced too:

Oil and Gold sold the fact:

Base metals loved the war:

Big miners (LON:GLEN) didn’t:

EM stocks (NYSE:EEM) gapped into madness:

EM junk (NYSE:HYG) is now a Russian missile of doom:

Treasuries were bid a bit:

Stocks were murdered then bounced. The always treasonous Wall St loves a good war. Smashed tech proved too strong a lure for the greedy:

Westpac has the wrap:

Event Wrap

The Russian invasion of Ukraine yesterday, and consequent sanctions imposed by countries, were the focal points for markets.

US Q4 GDP second estimate was left unchanged at an annualised 7.0%. Weekly initial jobless claims were in line with expectations at 232k, although continuing claims were lower than expected at 1.486m (est. 1.58m). New home sales in January were as expected at 801k (est. 803k, from an upwardly revised 839k). Chicago Fed national activity survey rebounded to +0.69 (est. of 0.16, prior +0.07). Kansas Fed activity survey rose to 29 (est. 25, prior 24).

Fedspeak continued to endorse a rate hike in March. Mester said a March hike is still appropriate, barring an “unexpected turn in the economy.” She noted that geopolitical events are adding to inflation and growth risks near term, but her outlook is still for a strong expansion in the economy this year. Bostic said he is very open to four or more rate hikes this year, with the Ukraine situation not “modally” affecting expectations for March. Barkin said “time will tell” if the developments in the Ukraine will alter the FOMC’s outlooks.

Event Outlook

NZ: The trade deficit is anticipated to remain wide in January given the ongoing strength in imports (Westpac f/c: -1250mn). Real retail sales in Q4 are estimated to have risen 5.0%. Continued activity restriction limited the recovery in spending. RBNZ Governor Orr speaks at Waikato University on inflation and the pandemic.

US: Personal income in January is estimated to have fallen 0.3%, spending +1.6%. Weakening purchasing power is becoming a concern, and strength in services is necessary for GDP growth to be above trend. The core PCE deflator is estimated to have risen from 4.9% to 5.2% y/y. PCE inflation has reached a 40–year high, and price pressures will only slowly abate through 2022. Also released are durable goods orders for January, and consumer sentiment (Michigan Univ.).

BofA has the analysis:

Markets are lurching from one Ukraine-related headline to the next. However, we continue to hold our broad FX outlook in G10, which primarily still implies modest USDstrength, particularly led by our EUR-USD forecast profile with a year-end forecast of1.10. We still have downside for USD against the Dollar Bloc, including our year-end forecast for USD-CAD of 1.23 (see the Chart of the Day), although we also recently made modest USD-positive adjustments to our Dollar Bloc views. Although we are not looking for a broader and more secular rise in USD, a hiking Federal Reserve will likely help support the currency this year.

G10 FX: monetary policy tailwinds persist for USD

USD continues to consolidate around levels prevailing since early December. We continue to expect another leg of USD strength, particularly against lower beta currencies predicated on US inflation and monetary policy divergence. We remain constructive higher beta currencies this year on our expectation of a broadening in the global recovery, but recent market volatility stands to delay prospects for appreciation.

The Fed continues to pivot hawkishly toward an ever-brisker pace of monetary policy normalization this year. Our economics team expects the Fed todeliver7hikesthis yearand4more next year, compared with market pricing of slightly more than 6and2hikes, respectively, in 2022 and 2023.

Meanwhile, after the recent repricing, the market expects too much from the ECB and the BoE relative to our house calls. We therefore expect relative central bank pricing to remain a medium-term USD tailwind as interest-rate differentials–still a key driver of G10 FX–remain dollar-supportive. Even with other central banks likely to hike this year, including now the Bank of Japan(Exhibit 1), the Fed’srate-hiking path should still windup being a USD-positive factor.

Global risk aversion has sharply increased, reflecting both interest-rate risk, as well as geopolitical stress. This has supported USD of late and could remain a source of additional broad-based strength if conditions further deteriorate.

EUR-USD: March Fed and ECB meetings

The March meetings of both the Fed and the ECB are of particular importance. The Fed iswell behind the curve, as inflation keeps increasing and has now reached a 40-year high, with the market pricing in a sizable probability for a 50bp hike in March.

Relatively speaking, the ECB seems to have an easier job for now(Exhibit 2). Followingthesurprisingly high inflation print for January, we expect the ECB to announce faster tapering in March, end QE by July, and hike in September and in December, to bring depo rates to zero by the year-end. The market is pricing at least two more hikes for next year, but it depends on inflation. We find a contradiction in pricing of more hikes next year and the consensus that inflation will drop below 2%. We expect the ECB to pause at zero in this case.

The challenge for the ECB will be a periphery sell-off if inflation remains above the 2%target next year, and the ECB has to keep hiking. The sharp widening of the periphery spreads after the hawkish ECB meeting in February was a red flag. Since then, ECB speakers, including Lagarde, have emphasized gradual tightening and policy sequence.

Forecasts: sticking with our view of USD upside for the majors in G10…

We continue to forecast EURUSD at 1.10 by the year-end, and the general tone of our FX forecasts stays the same, with modest USD upside against lowerbetaG10 (Exhibit3). The first quarter is coming to an end with EURUSD very close to our 1.13 forecast. The consensus for this year is 1.16. We see a stronger EURUSD next year, appreciating to 1.15, starting to move towards its long-term equilibrium, above1.20.Meanwhile, our USDJPY forecastremains118, indicating more USD appreciation potential ahead.

BofA actually sees AUD rising with DXY which I disagree with. But I think it is clear that Ukraine fallout will support AUD given its upwards pressures on commodity prices so that it does not fall as far as it would have otherwise during the Fed tightening.

Still, given the same pressures are likely to intensify Fed tightening, the eventual downside for AUD is likely to still be steep.