The tech-led equity sell-off has started to significantly spill over into FX. Since the sentiment jitters originated in Asia and are centred on semiconductor stocks, the Aussie and Kiwi dollar have been hit hard, alongside SEK and NOK, which tend to underperform as liquidity dries up in risk-off conditions.
The canonical safe havens USD, JPY, CHF are doing well, but only one - the dollar - can also offer an attractive domestic story from a growth and carry perspective. Whether this is a moderate correction in a stellar year for AI stocks or the start of a more prolonged equity downturn, USD should outperform while risk aversion holds. In the latter scenario, however, a potential dovish repricing in the Fed curve - if met with actual easing - could leave the greenback much weaker in the medium term.
US and Europe’s equity futures are stabilising this morning, suggesting consolidation may be more likely than another major leg higher in the dollar. But for now, we remain very cautious about picking a top in this USD move. We still don’t think this is the start of a new bullish USD cycle, but near-term momentum remains bullish. Fespeak has also added support, with the generally neutral FOMC member Austan Goolsbee saying yesterday that inflation is too high and going the wrong way.
The equity sell-off primarily drove yesterday’s EUR/USD drop, but PMIs also did little to challenge the narrative of diverging US-EU growth. While US surveys got a small bump from the Middle East de-escalation, Germany's service PMIs dropped from 48.1 to 46.8, dragging the composite further into contraction territory. That clouded an otherwise decent read for the eurozone, where the composite PMI at 49.5 is close to returning to expansion.
On the positive side for the euro, ECB Chief Economist Philip Lane sounded quite hawkish, warning that inflation is set to stay above 2% for some time. This looks like an attempt to push back against President Lagarde's dovish messaging on Monday, with Lane perhaps better reflecting current Governing Council consensus. There’s a good chance we’ll hear more ECB members offering a more hawkish stance for that reason.
Domestically, the picture for AUD remains strong, but is hardly relevant for near-term moves, considering the challenging external environment. Overnight, Australian headline inflation unexpectedly slowed from 4.2% to 4.0%, but the trimmed mean (the main core measure) accelerated from 3.4% to 3.6%. This second measure is what matters the most for the Reserve Bank of Australia. While we don't expect another hike from the bank, this print should encourage a still hawkish tone in upcoming communication.