Dollar Edges Higher as Markets Brace for Fed Moves and Stagflation Risks

Let's get to the big story.

Breakdown while the US dollar is slightly higher against most major currencies in New York morning trade and risk assets are starting the week mostly on the front foot.

But beneath the surface of this relief rally, a stagflationary shock is brewing.

Oil does remain stubbornly, but inflation remainsy this week.

The world's biggest central banks are set to voice policy challenges.

We've also got 1st quarter US GDP as well as core. and rate decisions from around the globe.

Well joining me this morning to weigh in on what we're seeing across the currency markets is Francesco Pesole, an FX Strategist at ING.

Well, good morning, Francesco.

Thank you so much for joining us.

So of course all eyes are on central bank policy announcements this week, but how hawkish does the Federal Reserve, the FOMC have to sound tomorrow to actually put a floor under the US currency.

Well, when you look at rate expectations, markets are not really hawkish, um, on the Fed, you know, when you compare it to what markets are pricing in for the European Central Bank, for example, where they're looking at over 50 basis points of rate hikes.

When it comes to the Fed, obviously we're not seeing really expectations for rate hikes.

So I wouldn't think that the bar is, is really too high, uh, but at the same time, we think there's a pretty good chance that we won't be hearing.

Anything particularly new.

Uh, when we look at the latest comments by Fed officials, they've been pretty clear that they just don't have enough data at the moment to make very strong projections of what the implications for monetary policy could be, uh, how the balance between inflation, inflationary impact, and the potential hit on growth and unemployment could be.

So I think for the moment we just won't be hearing anything particularly new and we'll just have to wait for another meeting probably.

And depending on which central bank we're talking about, we know that this energy shock in terms of inflation affects economies differently, and we have geopolitical hopes clashing with these harsh macro realities that you mentioned elevated. as well as oil supply risks.

So given the fact that we are seeing what we are in oil prices right now and the Strait of Hormuz, at least for now, remains effectively closed, how are you pricing the geopolitical risk premium at this moment?

Well, when you look at the ethic market, it's not really there, that geopolitical risk premium, uh, you know, dollar should be trading much higher probably if markets were seriously concerned, um, about a potential prolonged disruption in the trading Orvis.

Uh, I think markets have been trading pretty clearly on the optimistic side.

Uh, when it comes to the FX markets, uh, obviously when it comes to the equity markets, there are other factors at play there in the equity markets.

Um, so I believe at this stage we just markets remain pretty optimistic, um, and you know it's uh You know, we're heading into another round of negotiations with a lot of uncertainty, and, and of course if you look at the balance of risk, it's probably on the upside for the dollar, it's probably on the upside for oil still, but markets have shown a tendency to be a bit a bit reluctant to really price in the worst case scenario.

Yes, and when we take a look at the US dollar index this morning, it is slightly higher and it is up year to date.

But as you mentioned, when we're talking about the various FX pairs for the major currencies, we're seeing different actions.

So given your expectations for rate differentials this year, what do you expect to see in terms of the dollar index?

They are generally bearish on the dollar into year end.

Um, we still think that once the dust settles, uh, the ECB will be the one raising interest rates, the Fed will still be the one cutting interest rates at one point later this year.

So obviously we would be talking at a tighter rate differential.

Now, as long as oil remains above $100 obviously it's hard to make a case against the dollar, uh, but if towards the end of the year we do see that the oil prices come lower but we're left with tighter rate differentials between the eurozone and the US, then uh we think the euro dollar will be back at 120.

And finally, Francesca, before I let you go, of course we're paying attention to the geopolitical situation in the Middle East, and earlier we heard from the UAE and they said that they are planning to exit OPEC OPEC plus on May 1st.

So when it comes to some of the commodity currencies as well as any of the crosses, what are you paying attention to right now?

Why?

Well, I think interestingly we're mostly paying attention to what the equity market is doing.

Um, and the reason for that is that in the FX market at the moment, we saw commodity currencies like the Australian dollar, um, also the Canadian dollar, uh, the Norwegian croin doing particularly well, and that's because, uh, despite this being in an environment with higher oil prices where you would expect the US dollar to do well, the fact that equities are holding up very well, this is really preventing the dollar to benefit from its safe haven side of trade.

And uh instead markets prefer to play uh with currencies and the long currencies like the ones I mentioned that have a positive exposure to energy prices but also have a positive beat to global resettlement and in this case equities.

Um, so again, I would be looking mostly at this week's earnings in the US, uh, general mood in the equity markets uh for those currencies more than specifically what's happening with oil prices.

Well, Francesca, always great having you on the show.

Thank you so much for joining us today and thank you so much for sharing all of your insights.

Yeah.