Credit Agricole

Asia overnight

A lack of fresh news on the Russia-Ukraine front, as well as better-than-expected China PMI data, led to modest risk-on trading in the Asian session. Most Asian bourses were trading higher and S&P 500 futures slightly in the red at the time of writing. G10 FX traded in tight ranges during the Asian session, with the EUR and CHF underperforming and the AUD and USD slightly outperforming.

AUD: RBA still the ball-and-chain

The RBA left its policy parameters unchanged as widely expected and remained dovish in its accompanying statement. While the RBA continues to acknowledge the economy is recovering strongly and inflation is picking up faster than it expected, the central bank continues to note it is too early to conclude that inflation is sustainably within its 2-3% target. The key uncertainties around the inflation outlook remain how quickly supply-chain issues are resolved as well as the acceleration in wages growth. On the latter, the RBA believes it will be “some time” before wages growth accelerates to a pace consistent with the inflation target.

The RBA acknowledges the Ukraine crisis as another source of uncertainty on the inflation front, but refers to it as an external shock, which suggests the RBA will look through this impact unless it shows signs of being persistent. The RBA has said it will continue to watch inflation evolve, and so we continue to think the soonest time for a rate hike will be the central bank’s August meeting and after two upside surprises in inflation as well as further acceleration in wages growth. So, the RBA remains a ball-and-chain on the AUD for now. The currency, however, is being boosted by high commodity prices and its appeal as a hedge against commodity-based inflation.

USD: smiling, swift, scarce

The near-term USD outlook seems to follow closely the predictions of the so[1]called ‘USD smile’ analytical framework, according to which the currency will outperform during bouts of risk aversion and periods when the Fed is leading the global tightening cycle. Both USD-positives will be on display this week as investors continue to fret about the dual threat from the Ukraine crisis and the upcoming aggressive Fed tightening. On the day, the ongoing Ukraine crisis will attract attention as investors look for any indications that the end of the conflict is drawing near. In addition, focus will be on the ISM manufacturing for February as well as speeches from the Fed’s Rafael Bostic and Loretta Mester.

Both the data and Fed speak could confirm that the recent escalation of geopolitical risks and the economic sanctions on Russia may have only limited impact on the US economy and thus the Fed outlook. In turn, this should boost the appeal of the high-yielding, safe-haven USD. Looking beyond the ‘USD smile’, we also note that the recent exclusion of some Russian banks from SWIFT has led to a renewed USD scarcity in the global money markets that has manifested itself in the sharp widening of cross-currency basis swap spreads. In particular, the measures have disrupted global payments in USD and forced global financial institutions to aggressively try to get hold of the currency. While the Fed and other central banks can address the USD scarcity, a concerted policy response may take time to be coordinated. In the meantime, the USD can continue to trade at a premium.