A sharp rise in global interest rates, along with higher commodity prices and reduced risk premiums related to the Russia-Ukraine War, dominated the currency market in March. The currencies that did well benefitted from a number of other factors as well. Australia, New Zealand, Canada, and Norway saw a 50–75 basis point increase in 2-year yields, in addition to improved prices for their commodity exports. Their currencies gained versus the G-10 average. In Sweden, the 2-year currency rates also jumped 0.75% and the country enjoyed a relief from reduced negative tail risk in Ukraine. Conversely, the currencies of major energy importers with less scope to tighten monetary policy underperformed the G-10. Japan fit this profile perfectly and lost over 5% versus the G-10 average.
Figure 1: March Currency Return vs. G-10 Average
The Russia-Ukraine War remains intense and the humanitarian toll is unacceptably high. Investors did not react favorably to the War itself, but opposition from major EU countries such as Germany, against the embargo on Russian energy, reduced the risk of an extreme negative shock to regional growth leading to gains in currencies that were most impacted by the conflict.
Over the past couple of months, rising rates and commodity prices have overpowered the rising economic uncertainty factor and increased the equity volatility to elevate higher-yielding commodity currencies. Over the past couple of weeks, the recovery in equity markets to or above the pre-War levels has helped further that move. The commodity- and yield-driven rally appears a bit overdone in the short term given the rising risks of an economic slowdown and the higher likelihood that we are nearing peak monetary policy tightening expectations. These elevated risks suggest a more challenging short-term outlook for recent winners in currency markets as well as the continued resilience of the US dollar.
Figure 2: March 2022 Directional Outlook
The USD lost 0.10% against the G-10 average. The month began with a surge in the USD as investors preferred the safety of US assets in response to the uncertainty caused by the Russia-Ukraine War. The currency was also boosted by increased expectations of monetary tightening in response to an impressive 678k increase in non-farm payrolls versus expectations of +423k, and another rise in Consumer Price Index (CPI) to 7.9% YoY for March. As expected, the US Fed announced a substantial increase in the expected pace and magnitude of interest rate hikes during the meeting on 16 March. However, the USD fell back during the second half of the month as the currency lost some of its haven appeal as investors seemingly priced out some of the economic risks associated with the Russia-Ukraine War.
The USD is highly overvalued from a long-run perspective, but it is difficult to see it falling back while US rates continue to rise rapidly, uncertainty hovers over due to the Russia-Ukraine War, and supply chain disruptions from COVID-19 remain elevated. Until the macro environment stabilizes, the USD is likely to continue to find support. We may yet see higher highs for the USD against low-yielding currencies exposed to elevated commodity import prices and other collateral risks from the War. Currencies including the EUR, the JPY, the SEK, and to some extent the GBP stand out in this regard. Commodity currencies with strong domestic fundamentals and rising yields, the NOK, the AUD, and the CAD, appear overbought in the short term given the heightened economic uncertainty and risks of further spikes in equity market volatility. This risks a near-term pullback versus the USD, but they should hold up well versus in the medium term.
The euro fell 1.2% relative to the G-10 average. The month began with a steep drop in the EUR, in response to the intense uncertainty around the Russia-Ukraine War and the associated spike in European Union’s (EU) energy import prices. As Germany and others opposed extending sanctions to prohibit Russian energy imports, the Russia-Ukraine War risk premium was reduced, allowing the EUR to regain some ground. In the meeting on 10 March, the European Central Bank (ECB) announced an accelerated reduction in bond purchases, which further supported the EUR. However, despite the ECB tilting its focus toward its inflation fighting, support for the EUR was temporary due to the aggressive shift in other central banks’ monetary policy tightening expectations. The EUR fell back from its mid-month rally to finish lower.
We are broadly negative on the euro due to the risks from the Russia-Ukraine War. The War threatens the EU’s growth outlook, points to looser relative monetary policy for longer, and disincentivizes capital flows into the region. Equity markets may have recovered to pre-War levels and commodity prices are well off their highs, but we still see substantial risks going forward, which will likely keep downward pressure on the currency. Longer term, once the uncertainty over the War subsides (which could take very long in the worst-case scenario), we see room to have a more constructive discussion on the EUR. The current conflict is a clear negative for now, but it also incentivizes greater EU integration, higher fiscal spending, and a more rapid transformation toward alternative energy sources. All these factors could ultimately promote a higher long run potential growth rate and support a sustained post-crisis recovery in the EUR.
The pound struggled in March, finishing 2% lower than the G-10 average. Losses were steady throughout the month. Like the EUR, the start of the month had a negative tone as risks around the Russia-Ukraine War peaked and energy prices soared. Unlike the EUR, the GBP did not enjoy a mid-month bounce as investors worried that the Bank of England (BOE) may become more cautious in response to the crisis and focus on risks from upcoming fiscal tightening in the UK. The BOE raised the policy rate at its meeting on 17 March, but only by 0.25%, and delivered a more cautious tone, as feared, while other central banks signaled an acceleration in monetary tightening. This helped to perpetuate the downtrend in the GBP toward the month end.
Our view of the GBP is mixed. Near-term, we are neutral. Economic risks from a potential slowing of the EU’s growth, fiscal drag, and eroding consumer purchasing power from elevated inflation are negative for the GBP. The BOE is increasing rates but is not expected to reach the levels of tightening as expected in the US, Norway, Canada, Australia or New Zealand. However, we think that it is difficult to chase the GBP lower from here because it has already fallen to its 18-month low and growth/employment numbers continue to hold up well. Longer term, we are more constructive. After the geopolitical uncertainty resolves, we may see greater room for sustained GBP appreciation powered by its cheap valuation versus the long-run fair value, resilient fundamentals, rising policy rates, and our expectations for a broad weakness in the USD.
After a brief period of gains in early March on rising risk aversion and weaker equity markets, the yen trended lower toward the end of the month, down by a massive 5.3% relative to the G-10 average. The JPY’s outsized losses are not surprising given its recent sensitivity to yields differentials and the global risk sentiment. The combination of stronger equities and rising relative yields is the worst-case scenario for the JPY and that perfectly describes global market behavior in March. The Bank of Japan (BOJ) held steady to its yield curve control policy and shrugged off any negative impacts of the weaker JPY via its role in exacerbating the rise in import prices. Thus, Japan experienced the greatest divergence in relative monetary policy expectations among the G-10 currencies. Meanwhile, investor sentiment rebounded, sending equity markets back to the pre-War levels.
Our short-term model suggests more losses in the near future. In Japan, growth and core inflation are among the weakest in the G-10, incentivizing the BOJ to stick to its ultra-loose monetary policy. In contrast, we see potential for further upside in rates and monetary policy tightening in other countries. The potential for rising global risks from the Russia-Ukraine War and recessionary risks from the rapid tightening of global monetary policy may slow the pace of the JPY’s depreciation. But that appears unlikely to be significant enough to prevent losses outright. Long term, the JPY looks very cheap and is now near to its 30-year low on a real effective exchange rate basis. Once global inflation and expectations of monetary tightening peak, forces may well shift to push the JPY back toward its fair value. It does not look like we are close to that point.
The CHF lost 0.5% versus the G-10 average in March. The month started on a strong note alongside rising global risk aversion and substantial weakness in the EUR. The jump in February core CPI from 0.9% YoY to 1.3% reported on 3 March also helped the CHF by introducing some hope that the Swiss National Bank (SNB) would eventually tighten monetary policy or, at least, tolerate greater currency appreciation. As commodity markets fell from the highs and Ukraine risk premium fell, the CHF, a safe haven, also fell from an intra month gain of nearly +0.75% to a loss of nearly 1.5%. A late month dip in equity markets helped the CHF regain some of its lost ground to finish with a more modest 0.5% loss for the month.
Our view on the CHF is negative due to its ultra-low yields, low inflation, prospects for accelerated SNB intervention to limit further CHF gains, and extreme overvaluation versus its long-run fair value. We see merit in the argument that the SNB should begin to tighten monetary policy at some point but think that the degree and timing of such tightening are likely to lag the rest of the G-10, including the ECB. One caution to our negative view is that recent volatility in risky asset markets and the ongoing Russia-Ukraine War will likely limit near-term CHF downside.
The CAD enjoyed a substantial increase in yields on the back of expectations for greater monetary tightening as well as positive effects from elevated commodity prices. These positive factors pushed the CAD up 1.4% versus the G-10. In turn, rising yields were underpinned by impressive domestic economic data. Employment increased by 336k jobs versus expectations of only 127.5k, and CPI surprised higher at 5.7% YoY versus 5.5% expected. Even January retail sales surprised higher at 3.2% MoM against expectations of 2.4%, despite the lingering drag from the spike in Omicron cases.
Our CAD view has improved over the month given the strong performance of commodity markets and the local economy. The strength and breadth of our signals across equity markets, commodities, economy, and interest rates provide a confident basis for additional appreciation. However, that expected appreciation may come with higher volatility. We expect volatility to remain elevated given heightened commodity market volatility and the growing uncertainty of the impact of rapid monetary tightening. Longer term, the CAD outlook is mixed. The currency has the potential for sustained long-run appreciation versus the USD and the CHF but is cheap versus the GBP, the JPY, and the Scandinavian currencies.
The krone gained 0.5% against the G-10 average. The month started on a less positive note. The local security and growth risks from the Russia-Ukraine War became too large relative to the benefits of higher oil prices, causing the NOK to reverse much of its late February gains. This reversed again on the strong relief rally in equity markets, helping the NOK to return back into positive territory. That appreciation accelerated following a sharp 0.75% increase in the central bank’s projected interest rate path during the meeting on 24 March, ultimately pushing the NOK to a peak gain of over 2% versus the G-10 on 30 March. However, three-fourths of that gain was given up on the final trading day of the month following the announcement that the central bank would sell NOK2 billion worth of currency a day in April to convert excess tax receipts from the windfall profits from the petroleum sector.
Notwithstanding the near-term risks to the NOK from elevated equity market volatility, we are positive over both short- and long-term horizons. The NOK is historically cheap on a real effective basis and against our estimates of long-run fair value. Additionally, cyclical fundamentals also support appreciation. Potential risks arising due to the War as well as longer-term underlying supply/demand dynamics suggest continued oil market strength, which will only bolster Norway’s record trade surplus. However, the benefits of high oil profits will be partly diluted by the Norges bank’s plans to sell the NOK. In short, the NOK is a cheap currency with commodity support, rising yields, and solid growth fundamentals. We expect strong gains over time.
The krona was up 1.1% against the G-10 average. It continued to trade alongside risk sentiment around the Russia- Ukraine War and associated energy prices. As risk aversion and commodity prices spiked during the first week of the month, the SEK continued its post-invasion sell-off losing more than 4% versus the G-10 average. It was the hardest hit G-10 currency. The sharp reversal in energy prices brought Brent crude prices from a high near US$140/barrel on 8 March to a low near US$97 on 16 March. During that period, the SEK soared nearly 5% from its low. A positive core CPI surprise, 1% MoM versus 0.6% expected, also supported the recovery. That recovery was further validated at the Riksbank meeting on 16 March, where the central bank governor acknowledged the need to tighten monetary policy faster than previously expected. However, after already gaining 5%, the central bank’s shift put a cap on the SEK’s further appreciation.
The SEK remains among the cheapest G-10 currencies and is likely to remain so near term due to the divergence between Riksbank’s policy and those of other central banks, as well as the acute uncertainty regarding the EU’s growth outlook and the Russia-Ukraine War. The comments from the central bank indicate that it may relent and begin to tighten policy sooner rather than later. However, at this point it remains well behind most other central banks. We see room for recovery once we gain even a modest amount of clarity on the War and get more tangible changes in the monetary policy stance. For now, it may be best to express a positive view versus other low yielders such as the EUR and the CHF that are also exposed to the crisis.
The Australian dollar led the G-10 with a 3.3% gain versus the average in March. Higher commodity prices and increasing Australian yields created a strong environment for the currency. Domestic data was impressive, with unemployment tying its lowest level since 1978 at 4.1%. It had reached this low once, in March 2008. We witnessed rising business sentiment conditions and a strong positive surprise in February retail sales, +1.8% MoM versus 0.9% expected. The Reserve Bank of Australia has been cautious in tightening policy, but the commodity boom and the overheating domestic labor markets promise a shift toward tighter policy.
We remain broadly positive on the AUD on the basis of this strong fundamental backdrop. Over the very near term, we tilt more toward neutral because the February–March rally appears to have gone a little too far too fast. The potential for a further, albeit temporary, correction in commodity prices, near-term worries regarding the Russia-Ukraine War, as well as COVID-19-related lockdowns in China may weigh on the AUD. However, as China pledges to increase economic stimulus, it will likely limit the medium-term negative impact of the lockdown. For now, the balance of risks points to a modest pull back in the AUD before it can resume its rally.
The New Zealand dollar tracked the AUD closely to finish up 2.7% relative to the G-10 average. Strong commodity prices and high/rising yields supported the NZD. The domestic economy and labor markets looked strong, but recent signs of softening have continued. Credit card spending and consumer confidence weakened, the current account deficit came in at its widest since 2009, and home sales and building permits disappointed. Investors are beginning to worry that the Reserve Bank of New Zealand may slow down the pace of monetary tightening after it led the G-10 last year in raising rates.
Our tactical models have turned negative against the NZD due to softness in economic activity as well as weak domestic equity markets. Yields remain relatively attractive, but the risk that the central bank may respond to the decelerating growth environment while other central banks are becoming more aggressive may also pressure the NZD lower. Longer term, our view is more neutral. Relative to long-run valuations, the NZD appears attractive against the USD and the CHF but is not as cheap as other commodity currencies such as the NOK, the AUD, and the CAD. This is likely to restrain any upside in the NZD against the broad G-10 even over the long term.
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