FX Daily: Energy shock prompts broad FX deleveraging
The FX markets witnessed a subtle shift in drivers yesterday, as the energy shock triggered a widespread deleveraging of risk, causing cross-market volatility to spike. This risk unwinding is typically short-lived and sharp. Investors will need to see positive developments, such as lower energy prices or central banks' ability to ease policies, before re-entering trades.
USD: The focus may shift to US prices and the Fed.
Yesterday, we observed a subtle shift in the drivers of FX markets. While Monday was dominated by the impact of high energy prices on energy-importing/exporting currencies, Tuesday saw a broad deleveraging of open positions as cross-market volatility spiked. Equities took a hit, particularly in the financial sector, due to the large overweight positioning in that sector. It's important to monitor the story of redemptions in the private credit space, as it could be ephemeral to the overall sell-off, as seen in recent headlines like Blacktsone and Blue Owl.
Near-term market drivers of risk will likely revolve around two factors:
- Energy prices and the Straits of Hormuz: Whether energy prices can reverse lower and the Straits of Hormuz can reopen will be crucial. Risk assets briefly rallied last night after President Trump's comments about naval convoy support and insurance backing for shipping fleets. However, the market will need concrete evidence of these developments.
- Central banks' monetary policies: The ability of central banks to cut rates and support activity or avoid tightening policies will be essential. The inflationary risk of the energy shock is currently re-pricing the short-end of the curve, but this trend may reverse if equity losses persist.
The dollar has had a strong week so far, trading as high as 99.68 yesterday. However, investors may be cautious about chasing it through recent highs, and a clear improvement in the energy story is needed before re-entering short dollar positions.
EUR: 1.1500 may be the bottom of the range.
Long euro positioning, especially in asset management, left EUR/USD vulnerable yesterday, with a low of 1.1530. The terms-of-trade story and broad-based deleveraging are both impacting EUR/USD. The terms of trade story is more significant, and the duration of the energy shock will determine the currency's trajectory. Our base case suggests that operational intensity will decrease over the next week, and the Straits of Hormuz will slowly reopen, providing support near 1.15.
CEE: A chance for relief.
The region experienced a second wave of sell-off yesterday, and we believe the main impact of the shock occurred since the US-Iran conflict began. Despite multi-week highs in EUR/HUF and EUR/CZK, there were signs of relief at the end of yesterday's trading session. Oil prices stabilized, and more importantly, gas prices fell from their highs, giving CEE currencies a chance to recover today.
The National Bank of Poland's rate decision today will be crucial, as a 25bp rate cut to 3.75% seemed certain before the conflict. The Monetary Council's new forecast, showing lower inflation near the central bank's target but based on outdated oil price assumptions, will be closely watched.
TRY and RON: Central banks' ability will be tested.
Managed currencies in the region, the Turkish lira (TRY) and Romanian leu (RON), have faced a significant test of central banks' control in the last two days. In Turkey, February inflation confirmed a year-on-year increase for the first time since September, putting the Central Bank of Turkey in an uncomfortable position. TRY is also the largest carry trade in the EM space.
After the conflict broke out, the CBT comfortably maintained USD/TRY essentially unchanged, despite significantly reducing carry positions. However, this may not be a significant issue due to its high FX reserves. In Romania, EUR/RON is unwinding long positioning in FX and Romanian government bonds after a strong rally. The real activity in the market is revealed by the significant spike in FX implied yields, with 1M jumping by 90bps yesterday to 6.30%, close to the NBR key rate.
Looking ahead, we expect a similar development in Turkey and Romania, as central banks will not want to allow additional inflationary pressures, and current conditions are not suitable for a shift in EUR/RON levels.
