BBGFX Update: July 2023

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7/2/2023 4:00:00 AM

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BBGFX Update: July 2023

Monthly FX Update
July 2, 2023
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July 2023

Price pressures remain elevated but economic momentum slowed as Q2 wound down. Many market participants think this poses a dilemma for policymakers and are skeptical that the hikes signaled will be delivered because of economic weakness or financial strains. These developments are thought to limit the tightening cycle before the inflation genie can be stuffed back into the bottle.

Yet, this may underestimate the resolve of most of the major central banks in tackling inflation. Many seem willing to risk a shallow downturn if necessary to bring price pressures. Only if there are signs of a significant downturn or heightened financial stress, beyond what was seen earlier this year, would central banks not extend the tightening cycle into Q3, and possibly Q4. The Federal Reserve and the European Central Bank are likely to hike rates in July. The Bank of Canada may also move again after ending the conditional pause it announced in January and the surprise hike in June. The odds of hikes by the central banks of Australia and New Zealand seem slimmer. The Scandinavian central banks and the Bank of England do not meet in July, but they have not reached their terminal rates either.

The undervaluation of the euro and yen remain stark and near historically extreme levels. According to the OECD's model of purchasing power parity, the euro and yen are roughly 50% and 48% undervalued, respectively. Compared to the Plaza Agreement in September 1985 that saw the G5 coordinate efforts to drive the dollar down, a highwater mark of concerted action, the undervaluation now is greater. In January 1985, the undervaluation of the yen peaked near 24.5% and the German mark around 36%. For dollar-based investors, the price of EMU and Japanese assets, revenue streams, wages, and products are cheap. It is not about market timing, but the recognition that the extreme misalignment offers opportunities for some businesses and investors and that overtime it will correct. This adjustment could offer a significant contribution to total returns over the medium and longer-terms.

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Economic Calendar

July 3: Japan’s Tankan Survey, US Auto Sales, Canada Holiday
July 4: Reserve Bank of Australia, US Holiday
July 7: US and Canada Employment, Mexico CPI
July 9: China CPI and PPI
July 11: Reserve Bank of New Zealand, UK Employment, NATO Summit
July 12: Bank of Canada, US CPI, NATO Summit
July 16: China Q2 GDP and One-Year Medium Term Lending Facility
July 17: Japan Holiday, Black Sea Grain Deal Expires
July 18: Canada CPI
July 19: China Lending Prime Rate, UK CPI
July 20: Japan CPI, Australia Employment, UK by-elections
July 23: Spain Elections
July 24: Preliminary PMI
July 25: Australia CPI
July 26: Federal Reserve Meeting Concludes
July 27: Tokyo CPI, European Central Bank, US Q2 GDP
July 28: Bank of Japan (Updated Forecasts)
July 31: Eurozone Q2 GDP and CPI, Mexico Q2 GDP

Bannockburn's World Currency Index, a GDP-weighted basket composed of the currencies are the 12 largest economies was virtually flat in June after falling in April and May. Only three currencies in the index fell: Japanese yen (-3.5%), Chinese yuan (-2.1%), and Russian rouble (-8.5%). However, those three currencies account for nearly half of the non-US dollar part of the BWCI. The Brazilian real (+4.6%) and the Mexican peso (3.7%) were the strongest, but together they account for less than 4% of the overall basket. Among the major currencies, the Canadian dollar was the best performer, with a 2.2% gain (2.4% weighting) followed by the Australian dollar's 2.1% gain (1.9% weighting).

Barring a significant shock, we expect that the market convergence toward the Federal Reserve's forward guidance will help lift the dollar. The Bannockburn World Currency Index unwound the gain in the first half of June and returned toward the six-month low set in May (~95.00). We envision another 1.00%-1.25% decline and do not expect it to take out last year's multi-year low set near 93.20. In the bigger picture. The monetary tightening cycle we expected to have been largely completed by in H1 23, now looks to extend, possibly for some countries, like the Great Britain, into the end of the year. Meanwhile, Brazil (and Chile) seems well positioned to begin cutting rates in Q3, and Mexico in Q4.

Bannockburn Global Forex is a capital markets trading firm specializing in foreign currency advisory, hedge analytics, and transaction processing for closely held enterprises. We create distinctive value by combining the personal attention and flexibility of a boutique, with scalable efficiencies and expert counsel.

www.BannockburnGlobal.com

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