FX Update: Longer term observations beyond US CPI distraction.

Our Q2 Outlook, titled The Fragmentation Game is now out.
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FX Trading focus: USD primed to react to March US CPI release today, market feels very indecisive without a strong directional surprise from the data.

The market action of the last week for most USD pairs has proven woefully indecisive as most developments seem to fall short of a breakout and mean revert within the safety of the range. That’s largely been the case elsewhere as well, with a few partial exceptions - the Scandies and EURJPY  - discussed below. As the market narrative is one of wondering whether the inflation and labor market data will remain sufficiently hot for the Fed to hike “one last time” in May or June (about 18 basis points priced for the May 3 FOMC and 22 basis points priced for the June FOMC meeting suggest some see the risk that the Fed holds off on a hike in May, preferring June). Ahead of May 3, we really only have today’s CPI, the March Retail Sales up on Friday, three more initial weekly claims releases and the March PCE inflation data ahead of that May 3 meeting. Woe for traders if today’s data is conflicting or perfectly in-line rather than providing an obvious strong directional indication. A strong surprise in the core month-on-month CPI data (more than 0.2% below or above the 0.4% expected) likely needed for a strong reaction function.

We have the FOMC minutes up later as well, but the debate on the implications for policy from the banking turmoil in the minutes may be discounted significantly, given that the Fed has had three more weeks to digest the follow-on impact and that the market has already priced 100 basis points of Fed “easing” relative to prior expectations before the March 9 unraveling of the SVB.

But as we await the short term potential for the US March CPI to move the needle, it is perhaps worth rounding up a few long term observations:

Extreme Scandie weakness. Interesting to note the aggravated SEK and especially NOK weakness of late despite a constructive backdrop for risk sentiment (normally SEK positive) and the recent jump higher in oil prices (normally associated with NOK strength). What gives? Not entirely sure, but I did take a stab in my Q2 outlook piece in discussing whether the key here is simply an insufficient supply of domestic risk-free assets, in this case sovereign bonds, in which to park excess funds. This means that in the case of Norway that much of the oil and gas fund profits that are saved end up in offshore assets. Norway’s sovereign debt is a paltry 13% of GDP – down from a peak of 19% during the pandemic response. The longer term trajectory of the SEK fits quite well with the long term trajectory of Sweden’s sovereign debt as well, which is down to 18.5% of GDP (down from peak of 25+% during the pandemic response and nearly 33% back in 2015. Some enormous irony could lie ahead in which the expansion of domestic bond markets to address eventual economic weakness – particularly in Sweden due to housing distress, could mean a stronger currency via the provision of deeper local currency sovereign bond markets. Something structural to watch for even if we have no signs of this now. Sweden and Norway need to wake up – it’s bordering on a national emergency when your currency falls 15% in the space of six months as NOK has against the EUR.

Chart: EURNOK
The EURNOK rally accelerated yesterday on the release of the slightly hot Norwegian CPI (in-line with expectations at 6.2% YoY at the core vs. 5.9% in Feb and hotter than expected on the headline at 6.5% vs 6.1% expected and 6.3% in Feb. Traders should note how little traction NOK has gotten from the recent jump in oil prices. Norway’s approach to addressing increased fiscal outlays in recent years has leaned far more on “raiding” the Wealth fund rather than raising the funds via the issuance of sovereign debt. A deeper low risk NOK-denominated government bond market with reasonable yields would probably go a long way to arresting the NOK’s fall and better addressing high inflation than any monetary policy move. Until then, how high can EURNOK go? The only time NOK has traded weaker versus the Euro was in the brief period of extremely low oil prices during the pandemic outbreak months of early 2020.