Global FX: Bullish beta, bullish USD reinforced

Arindam Sandilya (0:03)

Hello, and welcome to this At Any Rate podcast. I'm your host, Arindam Sandilya, and I'm here with my colleagues, Junya Tanase, Patrick Locke, and Octavia Popescu, to discuss a much-awaited, keenly-watched, action-packed week in FX.

We opened the week with some kerfuffle around the AI trade, if you recall. It's been quite a while since then. That combined with the surge in oil prices, close to $110 on Brent, and more importantly, this breakneck rise in front-end yields across many DM rate curves that seem to generate March 20 to 6 type anxiety around the beginnings of a stack inflationary impulse in risk markets and several questions from investors around those. These days, when one utter the word stack inflation, our recency effect causes mines to immediately raise back to 2022 But I guess we are here on this call to provide you a reassuring word that things don't look even remotely close to March 26, much less 22 on our dashboard of growth and risk indicators. And if you look at new story-based accounts of stack inflation anxiety, it's barely visible on charts. And in any case, our beta, FX beta, i.e. carry, in monetary tightening environments of the kind we are seeing right now, tends to perform better than risk beta and other asset classes such as equities. Because FX carry these days has a poor inflation bias. So I guess message number one to our listeners is keep calm and carry on.

But the fact is that all this monetary tightening related process was very much a first half of the week story. New cycles move rapidly these days. And indeed all of this began to recede towards the back half of the week as oil prices started to come down somewhat. And most of the attention shifted to the three G4 central bank meetings that took center stage midweek onwards, the FOMC, Bank of England, and today, the much-watched rated Bank of Japan. So Patrick Locke, maybe let's start with you, the mothership, the Fed, clearly the sort of hawkish delivery that we were hoping for, given our bullish dollar stance. But I guess in some sense, it even surpassed our own expectations and led our friends in US fixed income strategy to up their yield forecast across the curve.

And also, I guess the July FOMC had taken away the September Fed has given it, if you were to construct them on dollars. You had a couple of days to now digest the outcome. The question is, where to from here? Is there a supply of more hawkish Fed surprises in store that can give us another big high of the DXY?

Patrick Locke (2:24)

Yeah, thanks, Arindam. There's a lot to unpack. And I guess just on your kind of introductory comments, I sit here and maybe I'm naive, but the stagflation commentary is against the backdrop, obviously, of continually re-rating the US higher, right? So I think we've taken up our third quarter tracking for GDP to 3.5. Atlanta's around 5

So the growth backdrop, in my opinion, here seems to continue to be quite solid, right? And I guess that the decent lead up into the Fed backdrop where the SEP revisions were all very kind of like pro-growth, right? Unemployment rate is basically flatlining at 4.1 for the entirety of the forecast horizon, so below Nehru, the Fed's estimate of Nehru at least. GDP was taking a little bit up and inflation was also kind of nudged higher and doesn't really kind of trend back to kind of target until like 29, which Mike Farolini is right up, kind of does suggest that there is kind of a demand side undertone here. And I'll come back to that, but my point really kind of being that the initial outset at the 2 o'clock was generally, I think, quite positive overall. And maybe they're just kind of like, for context, we've been a little uneasy kind of coming into this meeting, right? And so we were basically nailed on, fully priced, despite X Telecom pricing from the CPI trending at about 19 basis points on Core.

The run rate on Core CPI wasn't obviously altogether that hot on kind of a 3-month, 6-month annualized basis, which is what Warsh kind of leaned into on the momentum basis. So there was some reason to have some misgivings about just how fully priced we were. And I think for that reason, we and our rates colleagues have been noting probably that a majority of potential outcomes here, even if they delivered the hike, probably skewed towards not exceeding kind of expectations and pricing. So for the dollar, it was really, I think, quite constructive, the overall tone, the message, and the directness of the delivery, actually managing to take the short-end yield higher and the dollar higher by extension. So I think kind of threading the needle on the potential dollar positive outcomes here, really, I think, quite solid at the 2 o'clock. And then again, I think the message from the press conference was also reasonably reassuring. The main kind of quotes that we took away were the removing the dose of accommodation, hard press to describe financial conditions as restrictive. We'd heard the latter at least a little bit before, so it wasn't like a glaring new one, but neither did he kind of suggest that this was kind of one and done, right? So he didn't really kind of like repress dollar upside or anything like that in the press conference. And if anything, he kind of leaned into it against the backdrop of the dots clearly signaling more for this year, and then very much open-minded about next year, where I think the three or four looking for cuts kind of tilted the median back to unchanged, but a decent not still looking for another one next year. So I think all together that was pretty solid. And, you know, I think for perspective, we continue to kind of like shore up the kind of the hawkish side and the credibility concerns that emanated from July, from Jackson Hole and now from this week. And I think something important that we show in the weekly, please feel free to see our publication, is an exhibit that started to show that the dollar discount really started to widen basically immediately after the July FOMC. Now, I'd be remiss if I didn't cite that that was also two days before the BOJ intervention. And we know that, you know, dollar yen trading around like it has can obviously impact how the dollar overall screens versus fair value. But looking on our dollar twy basis where the yen weight is not altogether that significant, and even the DXY basis where obviously that overweighs euro, seeing that kind of risk premium expand after the July FOMC meeting certainly I think stands out.