Credit Ágricole: Weekly FX - FJElite

Energy markets and infrastructures are feeling the heat of escalating hostilities in the Middle East. The response of financial markets has been to frontload further tightening prospects for most major central banks, with the exception of the Fed, which is merely seen as being on hold. This contrasts somewhat with the communication from this week’s flurry of monetary policy meetings. Most banks opted for a wait-and-see stance and highlighted their readiness to act either way, while the Fed Chair stood out a bit by mentioning discussion around the possibility of the next rate move being a hike.

In FX, the USD has this week not been able to benefit much from a normally favourable combination of higher energy prices and lower equity. Aside from the reaction of money markets, the USD may have also been held back by what so far remains a major difference compared to 2022 and the aftermath of the Russian invasion of Ukraine. Despite the IEA already calling this year’s supply shock the biggest in the history of global oil markets, long real rates have overall held up much better than back then, as if growth prospects have barely been dented. Only the EUR and JPY real 5Y rates have actually fallen this month, although they are at the same time the two faring much better than during the first month of the invasion of Ukraine, when the contraction was actually about 40bp and 35bp worse respectively. The EUR and JPY could thus remain vulnerable to any eventual late re-assessment towards a grimmer long­term outlook globally, especially as EUR/USD has correlated well with its 5Y real rate differentials over the past five years. For the JPY, heightened threats of FX interventions could act as a backstop.

Leading indicators such as Tuesday’s flash PMIs for March are unlikely to offer a swift reality check regarding the potential damage to the medium-term growth outlook. Back in 2022, it took months for the survey to come to the conclusion that activity in the Eurozone was at best poised for stagnation. In this context, any eventual immediate deterioration could be taken more seriously, especially as since then the room for fiscal manoeuvre has been reduced drastically in some countries.

The Norges Bank could validate a more hawkish stance on Thursday, as it remains to be seen whether this year’s easing prospects have been pushed back or completely taken out of the table.