In our FX review this week, we talk about the lack of volatility in major crosses, the impact of another high inflation print on GBP, and where we see the direction for the USD in coming months.
A slow week limited ideas
Last week was a difficult one for FX traders. The markets were incredibly slow, meaning that movements in major pairs was very limited. Whether it was EUR/USD or GBP/USD, or alternative pairs such as USD/CHF or USD/CAD, there was no directional bias in order to make a play. For example, GBP/USD has now traded for almost all of February in a range from the high 1.34’s to the low 1.36’s.
Of course, some intraday players can still hope to snipe a few pips from playing these ranges, but the larger gains are going to be lacking until we see something breakout. Unfortunately, drivers for this over the coming couple of weeks are slim. The next real risk event for markets will be the US Fed meeting in early March. Until this arrives, volatility is unlikely to materially rally.
Even if we see an invasion of Ukraine by Russia, we struggle to see ripples through the FX market. So far, aggression and headlines have caused some short term moves. However, the surprise factor has gone, and we think an invasion is more priced in than not in current markets.
UK inflation jumps, but a high bar already set
The only real point of note from last week was UK inflation for January, which beat expectations slightly by coming in at 5.5% vs 5.4% expected. GBP crosses spike initially, but retraced gains as traders continued to play the range game.
As we’ve spoken about before, GBP crosses already have priced in high expectations of more rate hikes by the Bank of England. Given that analysts are expecting another four hikes this year, the bar is set high for GBP gains. On that basis, we think the range break for GBP/USD and GBP/EUR will come on the low side. Especially when considering the potential for the ECB to shift to a more hawkish position, short GBP/EUR is one of our favored trades at the moment.
Mulling over the US Dollar
Finally, it’s worth revisiting our longer-term strategy for USD. In a similar way to GBP, market expectations range from 4-7 rate hikes from the US Fed this year, starting in March. We think that this makes the upside limited in coming months, given the rich pricing.
However, there aren’t many drivers we see for the greenback to materially depreciate. A war in Ukraine would keep it bid, as would any further jitters in equity markets. A move lower in yields (coupled with a repricing of rate expectations from the Fed) would be one reason for a slump. Yet with inflation above 7%, why would the push back in yields strike anytime soon?
Putting that altogether, we think USD pairs are again likely constrained to recent ranges, with a short term strength but medium term weakness as pricing recalibrates in the summer.