XE Market Analysis: Europe - Mar 22, 2021

A plunge in the Turkish lira jolted global markets, following the sacking of the nation's central bank governor, and with the credibility of the new governor in question. Many developing world currencies were pulled lower as a mostly risk-off sentiment ensued in global markets. Japanese investors are reportedly exposed to the high-yielding lira, which was behind an outsized 2.1% tumble in the Nikkei 225 stock index today. Australian and Chinese equity markets still posted gains, though most other markets decline. U.S. equity futures are showing declines of 0.3% or more, as of early London. The impact on the main currencies has been moderate so far, with the dollar firming, despite a decline in Treasury yields, and the yen also gaining following an early-session wobble in Tokyo. The DXY dollar index lifted to a 92.15 high, which is 2 pips shy of the 17-day peak that was seen on Friday, while EUR-USD edged out a 17-day low at 1.1871. Cable posted a six-day low at 1.3818, and AUD-USD pegged a five-day low at 0.7703. USD-CAD, bucking the trend, settled about half a big figure down on the 10-day high the pair saw on Friday, at 1.2549, despite a softening in oil prices. USD-JPY ebbed to the mid 108.00s, and most yen crosses saw a similar sinking price action, tough the magnitude of movement was limited. Regarding the situation in Turkey, President Erdogan sacked the central bank's chief, Naci Agbal, who had only been in the position since last November and was seen as a credible, and orthodox, governor by markets, who had overseen a rebound in the lira from record lows. The central bank under Agbal last week announced a bigger than expected 2 percentage point interest rate hike, to 6.75%, to tackle inflation that is running above 15%. Russia and Brazil lifted interest rates last week for similar reasons. Much of the problem concerns the credibility of Agbal's replacement, with Sahap Kavcioglu, who wrote in an newspaper article in Turkey last month that "interest rates will directly lead to inflation," which is of course back to front to monetary policy orthodoxy, though a view also shared by Erdogan. The debacle will lead to capital flight from Turkey, unless capital controls are imposed. It also comes at a challenging time for emerging markets, given the rise in borrowing costs in the U.S. and elsewhere, and with inflationary pressures bubbling up. The Turkish lira was showing a loss against the dollar of about 17% at the lows, though has settled with a decline of about 10%.

[EUR, USD]
We remain bearish on EUR-USD. The ECB last week surprised markets by announcing a ramp up in its asset purchase program in an effort to dampen rising yields. Markets are also focusing on growth and yield differentials, and the U.S. economy is widely seen outpacing the Eurozone and other peers this year, thanks in large part to the massive upcoming fiscal spending spree. Eurozone interest rates are near the most negative in the world (barring Swiss rates), and there is little expectation for the ECB to tighten policy, contrasting to the debate about the Fed, and the possibility it may be forced to tighten sooner than expected.

[USD, JPY]
The yen has lifted over the last couple of days amid the narrowing in the U.S. over Japan yield differential (amid a correction in U.S. yields), alongside a backdrop of sputtering global stock markets. The BoJ last week widened the target band under its yield curve control policy and removed explicit targeting on ETF purchases, giving the central bank room to draw in stimulus. We continue to expect that the yen will retain an overall softening bias, with JGB yields to remained relatively rooted to U.S. Treasury and other sovereign yields. The Japanese currency is registering as the weakest of the main currencies on the year so far because of this.

[GBP, USD]
Cable posted a six-day low at 1.3818 on the back of dollar firming. The pound continues to register as the strongest of the main currencies on the year so far, reflecting both a paring in the Brexit discount and UK's world leading vaccination program. Nearly 40% of the population have now received at least one dose of a vaccine, and only Israel and UAE are ahead. The BoE at its March policy meeting last week didn't disappoint, leaving policy settings unchanged while noting the successful Covid vaccination program in the UK and the government's reopening from restrictions as being consistent with a slightly stronger outlook for consumption growth in the second quarter of 2021. The BoE also noted that the U.S. fiscal stimulus package should provide "significant additional support to the outlook." But the 'Old Lady' also took trouble to emphasize that it will not tighten policy until there is clear evidence that its mandated 2% inflation goal is being met sustainably, suggesting, like the Fed, that it's not in the mode for pre-emptive tightening given flat Philips curve. This week's UK calendar is highlighted by labour and inflation data, alongside the preliminary PMI surveys for March, which are expected to show a moderate expansion in private sector activity.

[USD, CHF]
Policymakers at the SNB retain a chronic disquietude about the franc's value. Unlike most central banks, the SNB explicitly incorporates the franc into monetary policy to ward off speculative purchases of the currency, which would impart deflationary forces (via cheaper imports) with the consequential impact of an unwelcome tightening in real interest rates. The central bank repeated at its latest quarterly monetary policy review that the franc remains "highly valued" and said it is ready to intervene directly in the foreign exchange market.

[USD, CAD]
USD-CAD, bucking the greenback firming trend, settled about half a big figure down on the 10-day high the pair saw on Friday, at 1.2549, and despite a softening in oil prices today. The odds for an upward direction from here currently look greater than a downward direction. We expect oil prices to remain soft, given the demand destruction being caused by the re-implementation of lockdown measures across much of Europe. We have been noting that while oil prices have been ascending for five consecutive months, upside momentum has been weakening. Prices have become quite lofty, having long since been re-established to pre-pandemic level norms, while global demand has continued to lag behind pre-Covid levels. The OPEC+ group have maintained tight quotas through to April, though the discipline is looking increasingly likely to falter, with Russia in particular chomping at the bit to increase supply. U.S. shale production will also continue to ramp higher, despite some hindrances imposed by the Biden administration.