Instimatch - FX morning commentary - 26/2/25

Good morning

A relatively light Wednesday in terms of data, with US home sales and building permits likely the highlights. From the Bank of England we have Dhingra speaking on the interaction between trade and monetary policy, which is very topical.

On the geopolitical scene, Ukraine agreed to terms with the US on a minerals deal. The deal does not entail any US security guarantees or continued flow of weapons. However, the deal can be seen as part of a bigger puzzle, broadening relations with the US to strengthen Ukraine's prospects after three years of war, according to Ukraine's deputy prime minister and justice minister who led the negotiations. Zelensky is planning to travel to Washington on Friday to sign the deal.

Same dynamics were at play for a third session straight with US assets starting to discount the possibility of a stagflation rather than a goldilocks scenario for the US economy.  US Consumer Confidence fell to its weakest since June 2024, as some of the post-election related optimism faded, coupled with increasing concerns about the economic and inflationary impact of tariffs from the Trump 2.0 administration. In particular, while the present situation sub-component held up better, expectations for the future fell meaningfully. Taken more broadly, this data point fits in with increasing signals that policy uncertainty is having a meaningful impact on consumer and business sentiment, and is likely to have a real economic impact down the line on investment and growth.

Risk sentiment has been quite strong in absolute terms in Europe and China this year, and perhaps for good reason given the prospects of increased defence spending in Europe and AI related optimism in China. However, traders are nonetheless sceptical that this can continue to the same extent given the plethora of tariffs down the line.

The USD index rose marginally from a 3-month low in Asian trading to 106.53 as the greenback shows still more signs of fatigue. The US 10-Y yield has now fallen to 4.29% (the lowest level of the year) driven by a dip in consumer confidence, and a ratcheting down in the terminal funds rate. The direction of yields was also downward pointing in Europe, but to a much lesser extent.

EUR/USD is trading back below 1.0500 at 1.0494 after testing the YTD top at 1.0533.  Meanwhile, the ECB’s Schnabel is turning increasingly hawkish and during a speech at the Bank of England gave arguments for why short rates could stay higher compared to pre-Covid. The reasons cited include persistently large fiscal deficits and quantitative tightening and she underlined that deglobalisation can structurally increase inflationary pressures.

GBP/USD came under some profit taking pressure leaving the pair holding losses just below $1.2650.

USD/JPY dropped below 149 yesterday in response to the sharp decline in oil prices and US bond yields that followed an overall deterioration in risk sentiment in financial markets.  Traders continue to build short positions in USD/JPY with the pair now closing in on a soft target of 147.

The Australian dollar weakened on Wednesday following a softer-than-expected consumer price index inflation print for January, which showed headline inflation remaining steady from the prior month. AUD/USD fell 0.3% to $0.6328, but further losses in the Aussie were limited as underlying CPI inflation rose, coming close to breaking above the top end of the RBA’s 2% to 3% target range. 

From an FX perspective, KRW is getting some reprieve on the back of both global and also local factors, with the Constitutional Court ruling on President Yoon impeachment expected in two weeks’ time.  Meanwhile BOK Governor Rhee Chang-yong said that market expectations of two to three cuts this year were in line with views at the BOK, while the 2.75% policy rate is in the upper range of the neutral rate and not in the mid-range, some of his first indications of the longer-term outlook of policy rates.

The Chinese yuan remained weak, with the USD/CNY is trading slightly firmer at 7.2585.  USD/INR pair steadied after breaking back above 87 rupees this week.  Overall, traders are positioning for the INR to continue weakening with the pivot towards rate cuts and increasing liquidity by the RBI, and consensus forecast USD/INR at 88.50 by year and with another 50bp of rate cuts likely by RBI.