FX Daily: Inflation becomes a tail risk

USD has the upper hand over negative yielding currencies amidst inflation risks
Philip Wee13 Oct 2021
    Photo credit: Unsplash Photo

    DXY closed at a new year’s high of 94.5 on inflation risks. St Louis Fed President James Bullard backed a decision to start tapering asset purchases in November and Fed hikes next spring or summer. Fed Vice Chair Richard Clarida believed the “substantial further progress” criteria for tapering asset purchases has exceeded its price stability mandate and almost met its employment mandate. Atlanta Fed President Raphael Bostic no longer considered high inflation as transitory. Last week, former US Treasury Secretary Lawrence Summers believed interest rates and the unemployment rate were below their natural rates and stoking inflation.

    In its World Economic Outlook released on Monday, the IMF called on central banks to be “very, very vigilant” on inflation and take early action to tighten monetary policy before price pressures become entrenched. The IMF projected inflation to rise sharply for the rest of 2021 before moderating in mid-2022 and falling back to pre-pandemic levels. Although the IMF downgraded 2021 global growth to 5.9% from 6.0%, it did not subscribe to stagflation risks. Even so, investors could not shake off this tail risk. Dow, S&P 500 and Nasdaq Composite fell 0.3%, 0.2% and 0.1% respectively in the overnight session with all indices below their 100-day moving averages. While the US 10-year treasury yield fell with equities to below 1.60%, bond yields will rise again if the Fed falls behind the curve on inflation.

    Not surprisingly, the weakest currencies in the DXY were the negative yielding JPY, EUR and CHF which depreciated 9.1% ytd, 5.6% and 4.9% respectively this year. According to Bloomberg, the total market value of negative yielding debt worldwide fell USD1 trillion last week, its largest drop since February when US bond yields were also rising. USD/JPY is likely to test its 115 resistance after it broke out of its 3Q21 range between 109 and 111. With CPI inflation in Japan negative since October 2020, the Bank of Japan has backed new Prime Minister Fumio Kishida’s pledge to end deflation through expansionary monetary and fiscal policies and economic growth. Likewise, EUR/USD is set to test 1.15 after it fell decisively below the year’s support at 1.17. Speculators turned net short EUR for the first week since March 2020, convinced that the European Central Bank lacked the Fed’s urgency to address what it considered to be transitory inflation. It did not help that the ZEW Eurozone expectations of economic growth fell for the fifth month to 21.0 in October from a peak of 84.0 in May. USD/CHF can revisit the year’s high of 0.9473 on 1 April; the support at 0.9250 has held up well so far this month. On 22 September, the Swiss National Bank confirmed that it intervened in 2Q21 to prevent the CHF from appreciating too much. This largely explained why USD/CHF tried and failed to break below the psychological 0.90 level in May-June.

    In Asia, the Bank of Korea signaled a rate hike at its next policy meeting on 24 November. BOK is also considering interventions to support the KRW which has depreciated 9.3% ytd to become Asia’s second weakest currency. Although the THB outperformed on Tuesday from Thailand’s plans to reopen its borders to some vaccinated tourists from 1 November, it did not change its status as the worst performer (-10.4% depreciation) this year. At its last policy meeting on 29 September, the Bank of Thailand raised its growth forecast and pushed back against rate cut expectations. Even so, the KRW and THB are still highly correlated (at 71.3% and 79.5% respectively) with the JPY, the worst G10 currency. Contrary to consensus, we do not see the Monetary Authority of Singapore keeping the status quo at its policy review tomorrow. We believe that the MAS will replace the zero-appreciation path of the SGD NEER policy band with a modest and gradual appreciation path. Having upgraded its 2021 growth and inflation forecasts, Singapore is a price-taker economy that is unlikely to ignore the inflation risks in the world. Neither do we expect USD/SGD to buck the trend of a rising USD worldwide.


    Philip Wee

    Senior FX Strategist - G3 & Asia
    [email protected]

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