FX Daily: Energy shock sparks widespread FX deleveraging
The FX markets witnessed a subtle shift in drivers yesterday, as the energy shock triggered a broad deleveraging of risk, causing cross-market volatility to spike. These risk unwinds are typically short-lived and sharp. Investors will need positive news, such as lower energy prices or central banks easing policy, before re-entering trades.
Authors
USD: Focus shifts to US prices and the Fed
Yesterday's FX market shift was subtle. Monday's focus on energy prices' impact on energy-importing/exporting currencies gave way to Tuesday's broad deleveraging of open positions as volatility spiked. Equities took a hit, led by financials. The sell-off was driven by the sector's large overweight positioning. The private credit space's redemption story, as seen in Blacktsone and Blue Owl headlines, seems ephemeral in the broader sell-off. However, the spike in volatility and rising Value-at-Risk metrics have prompted a broad reduction in position sizes, benefiting the dollar as investors were short. We predict some overnight headlines, like South Korea's Kospi index falling 12% after a 50% run-up year-to-date, will follow this trend.
Near-term market risk drivers will likely revolve around energy prices and central banks. If the Straits of Hormuz reopens, energy prices may reverse lower. Central banks' ability to cut rates and support activity or avoid tightening policy will also be crucial. Risk assets briefly rose last night after President Trump's comments on naval convoy support for shipping in the Straits and US federal institutions backing shipping insurance. However, the market awaits evidence of these actions. Energy markets remain strong.
Central banks' inflationary risk re-pricing the short-end of the curve trend briefly reversed yesterday with intensifying equity losses. Unless another major equity sell-off occurs today, the hawkish re-pricing of the short-end of the curve is likely to dominate, benefiting the dollar. This theme is supported by potential ADP release data, indicating the Fed's assumption of abated labor market risks. The ISM services index's prices paid component will also be crucial. The Fed's Beige Book, ahead of the 18 March FOMC meeting, may further scale back expectations for two Fed cuts this year, currently priced at 45bp of easing.
The dollar's strong week is attributed to these factors, with DXY reaching 99.68. Investors may not chase it through 100.00/100.35 highs. Clear energy story improvement is needed before short dollar positions are considered.
Chris Turner
EUR: 1.1500 may be the range's bottom
Long euro positioning, especially in asset management, left EUR/USD vulnerable yesterday, dropping to 1.1530. The terms-of-trade story and broad deleveraging are impacting EUR/USD. The terms of trade will be the more significant theme, with the energy shock's duration determining EUR/USD's future. Our base case predicts operational intensity decrease and Straits of Hormuz reopening over the next week.
Without major Gulf headlines today, conditions may calm, and EUR/USD could find support near 1.1550/1575.
Chris Turner
CEE: First chance for relief
The region saw a second wave of sell-off yesterday, and we believe the main shock occurred since the US-Iran conflict. Despite multi-week highs in EUR/HUF and EUR/CZK, EUR/PLN jumped to April 2022 levels, relief emerged at the end of yesterday's trading. Oil price stabilization and gas price falls from highs, despite ongoing conflict headlines, offer CEE currencies a recovery chance today.
The National Bank of Poland's rate decision today is crucial. A 25bp rate cut to 3.75% seemed certain before the conflict. The NBP's decision is now uncertain, but a cut remains the baseline for economists. The Monetary Council's new forecast, with lower inflation near the central bank's target but outdated oil price assumptions, will be closely watched.
February inflation in the Czech Republic will be published this morning. The market and central bank expect no change at 1.6% YoY, while economists predict a decrease to 1.4%, calming the sell-off in rates. However, market attention is likely lower than usual, requiring a significant surprise in one direction for a substantial reaction.
Frantisek Taborsky
TRY and RON: Central banks' test
The Turkish lira and Romanian leu, managed currencies in the region, have significantly tested central banks' ability to control their currencies in the last two days. Turkey's February inflation, the first year-on-year increase since September, puts the Central Bank of Turkey in a challenging position amid the US-Iran conflict and rising oil prices. USD/TRY has been stable, with CBT reducing carry positions, but FX implied yields have spiked, tightening monetary conditions.
In Romania, EUR/RON is unwinding long positioning in FX and Romanian government bonds after a strong rally. EUR/RON spiked above 5.120 yesterday but returned below 5.100. Significant FX implied yield spikes indicate most long positioning has been unwound, making the situation more balanced. Excess liquidity decreases in official NBR data will be notable.
Further, we expect a similar development in Turkey, as the central bank won't allow additional inflationary pressures. Current conditions are unsuitable for a EUR/RON level shift.
Frantisek Taborsky
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