Yield Trends will continue to Dominate Global Exchange Rates, Threat of Complacency in Global Equities
There has been an important shift in global market dynamics this week with a surge in bond yields.
There are increased fears over inflation, especially with strong and sustained upward pressure on energy and food costs.
In this context, markets expect that the Federal Reserve will have to tighten monetary policy much more aggressively to curb inflation expectations.
Low-yield currencies, especially the yen, will remain vulnerable in the short term. There will, however, be a growing risk of a sharp correction, especially with increased concerns over the threat of global recession.
Pound (GBP) Exchange Rate Outlook
The Pound to Dollar (GBP / USD) exchange rate posted notable gains on Tuesday.
Global equity markets held firm which provided an element of support for the UK currency with markets also expecting a strong inflation reading which led to short-term fund buying.
There were also expectations that Chancellor Sunak would announce a fiscal support package which would cushion the economy to some extent and could also give the Bank of England greater leeway to raise interest rates.
GBP / USD surged to highs at 1.3300 before a retreat to 1.3260 despite a jump in inflation to a 29-year high of 6.2% from 5.5%.
Chancellor Sunak will be keen on political grounds to produce a rabbit out of the fiscal hat, but expectations are already high and any imposition of a windfall tax would hurt equities.
Overall, GBP / USD is likely to have priced in support measures and unlikely to make further headway in the near term.
Euro (EUR) Exchange Rates Today
Overall confidence in the Euro-zone economy remains fragile, especially with concerns over the longer-term impact of higher energy prices.
There is also pressure to curb Russian energy imports and any disruption to supplies would cause major damage.
The Euro was, however, resilient during the day with the Euro to Dollar (EUR / USD) exchange rate finding support below the 1.1000 level and rallying to 1.1035 amid a covering of short positions.
There were expectations that EU countries would boost fiscal spending.
Most investment banks remain bearish on EURUSD.
Scotiabank noted; “Markets are already showing around an 85% chance of two 25bps hikes in 2022 – which we think is the most that the ECB will hike by this year – so there is limited scope for EUR gains on a more hawkish tone from the ECB.”
The bank added; “With the Fed moving more aggressively and overshooting its neutral rate, yield differentials will remain a EUR headwind over the next few quarters. We see the EUR aiming for a re-test of 1.08 in coming days / weeks on war and Fed / ECB risks. “
US Dollar (USD) Exchange Rates Outlook
The dollar has continued to gain support from the increase in US bond yields, especially with expectations that the Federal Reserve will hike interest rates more aggressively to curb inflation pressures.
The Dollar to Yen (USD / JPY) exchange rate surged to a fresh 6-year high around 121.40 before a limited correction.
The Japanese Finance Ministry is uneasy over trends, especially given the speed of the yen decline which will put further strong upward pressure on energy costs, and warned that it was monitoring the situation closely with the potential for further verbal intervention.
Overall yield trends will continue to support the dollar against low-yield currencies if equity markets hold firm.
The yen has been subjected to further strong selling pressure in global markets with the yen at a major disadvantage as the Bank of Japan continues to target 10-year yield close to zero.
The Pound to yen (GBP / JPY) exchange rate surged to a 5-year high around 160.80.
The Swiss franc was more resilient, but the Pound to Swiss franc (GBP / CHF) exchange rate posted 4-week highs above 124.0.
Commodity currencies have maintained a strong underlying tone amid strength in global prices, although there has also been some pressure for a correction.
The Pound to Australian dollar (GBP / AUD) exchange rate remains was again able to find support just below the 1.7750 level with a tentative recovery to 1.7800.
The Pound to New Zealand dollar (GBP / NZD) exchange rate posted 4-month lows just above 1.9000 before a recovery to near 1.9100.
The Day Ahead
There are no major economic data releases during Wednesday with global trends in bond yields continuing to have an important impact on exchange rates.
Rhetoric from Fed officials will remain an important focus during the day.
Ukraine developments and trends in oil prices will also continue to be very important during the day with the risk that equity markets have become complacent over underlying trends and vulnerable to a sharp correction, especially with major concerns over the Ukraine situation.