In the latest commentary, Bank of America provides crucial insights into the evolving landscape of global rates and FX ahead of the second half of August, particularly focusing on key market risks and outlooks. Per the full note source, the firm emphasizes the need for traders to recalibrate their positions in light of potential volatility stemming from upcoming risk events. The strategic guidance not only offers updated core FX views but also highlights how shifting market conditions will shape the behavior of various currency pairs over the summer months.
What the desk is arguing
The desk postulates that institutions should remain vigilant regarding emerging risk events that could disrupt existing currency trends as August unfolds. This perspective is framed within the broader context of BofA’s assessment of the market's positioning, which indicates increased uncertainty tied to global macroeconomic developments.
Supporting this stance, the desk notes that the prevalence of uncertain macro indicators, including fluctuating economic data releases, poses a risk for traditional currency movements. As a result, traders are advised to reassess their exposure, factoring in not only the expected rate paths but also any geopolitical risks that may arise.
Where it sits in our coverage
Currently, our internal consensus target sits at 1.075 for the EUR/USD pair, with a range reflecting expectations from 1.04 to 1.12. Notable projections around this include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns with the broader market expectation where the upper bound reflects optimism in anticipated currency strength while the lower end is more defensive.
How other firms see it
Firms such as jpmorgan have aligned views with the notion of strengthening EUR/USD, while bofa currently presents a contrary stance leaning towards weaker projections. This divergence highlights differing interpretations of risk appetite and economic resilience.
As we assess this situation, it is valuable to monitor related dynamics, particularly the ECM and ECB rate decisions, as they will significantly impact EUR/USD movement as well as sentiment across the broader FX landscape.
01Investors should recalibrate exposure based on updated market outlooks provided by Bank of America.
02Emerging risk events in August are likely to introduce volatility in currency markets.
03The current consensus targets reflect a cautious but optimistic stance on EUR/USD.
04Traders must remain aware of both macroeconomic indicators and geopolitical unrest.
Market implications
Traders should pay close attention to how EUR/USD behaves against the backdrop of July's closing and August's shifting risk events. A pivot point around 1.075 could indicate larger market shifts if volatility increases, especially in response to macro indicators slated for release.
Risks to this view
Should core economic data indicate resilience in the US economy or a surprise dovish shift from the ECB, expectations for the EUR/USD could shift drastically, invalidating the thesis underpinning the current consensus.
Hello, and welcome to Global Research Unlocked, the interest rate in FX series. This podcast is based on our weekly client conference call, where our strategists, along with guests from other parts of Bank of America Global Research, discuss the most topical and pressing questions faced by our market. I'm Mark Cabana, Co-Head of Global Rate Strategy at B of A Securities.
Wonderful. Well, thank you all for joining. It is mid-August, right before us in global rates research are going to take a couple of weeks off, but we wanted to check in with you before we take our summer break, let you know how we're thinking about things.
And with me today, I have Katie Craig and Adarsh Sinha. Adarsh obviously heads up our FX research team, and we wanted to let you know what we're going to be watching as we go into this break. Now, look, from a market's perspective, last week, in the last week, we had a pretty notable bull steepening of the U.S. rates curve.
Japan behaved somewhat differently, but in the U.S., what we had was really broad macro data that indicated much less urgency for the Fed to be hiking. That was clear with not only the retail sales data this morning, which was soft as our credit and debit card data would have suggested, another reason to check out our incredible credit and debit card data, but we also had soft inflation through CPI and PPI. And since the last time we spoke, we had a soft labor report as well.
So all of those things caused the market to push out and reduce timing and extent of Fed hikes. As I see it right now, we have just about 7.5 bps priced for September. We only have about 30 bps priced for the total cycle, and really, it seems like barring a big shift in data, the Fed can sit tight in September.
We also had pretty notable shift in views with regards to Japan. Media are now reporting that the BOJ will be hiking faster. That has caused our team to also change its views around the BOJ.
We now expect the BOJ to raise rates in September and December of this year, March and July of next year. That'll put the policy rate at 2% by the middle of next year. And notably, that is where our clients think is necessary in order to stabilize dollar yen.
So clearly, a more rapid pace of hikes coming out of Japan. Now, to unpack some of our views and tell you what we're watching over the next couple of weeks, we are going to bring in Katie and Adarsh. And I wanted to start with Katie, given there was a pretty notable shift in views on the U.S. rates outlook.
Katie, do you want to tell us what those changes are? And how would you respond to anyone who might suggest that you're overreacting a little bit? Sure.
Yeah. I'd say the softer macro backdrop has been the main reason for our flip on U.S. rates views. The main focus in the U.S. has recently been on the combination of softer labor and inflation data, which has shown some disinflation.
I would say that's what's really maturely changed the policy conversation. July employment data showed some continued moderation in hiring and wage growth, while inflation data was probably consistent with further cooling and underlying price pressures. And this, to us, has shifted from our expectations for Fed tightening to maybe a more patient Fed.
We've obviously seen some of that already reflected in the market pricing, which you mentioned. We had a 30 percent chance of a hike in September, down from 70 percent just two weeks ago. So for much of the year, our bias was for higher front end rates and a flatter curve.
But the recent data has undeniably shifted that balance. Hiring is moderating, like I mentioned, and inflation has some disinflation. So we think that the Fed can likely be more patient here.
And as a result, we closed our two year, our pay two year recommendation and our two's ten's flattener. Thanks, and just on the shift in Fed views as well, in our Global Rates Weekly, we were highlighting the, quote unquote, jump risk that is associated with the September to December meetings. And what we mean by jump risk is the fact that historically, the Fed, at least since the 90s and since 1990, has never started a hiking cycle ahead of a general election.
Now, the Fed is obviously independent, and if the data tells them to do something, they're going to respond. But it's just a higher bar for them to start something new ahead of a general election. And again, since 1990, we have elections every two years in the U.S.
There has never been a hiking cycle that started the meeting before a general election. So that really means that October is basically out. And the market is pricing still roughly five bips of hikes in October.
We just think that the bar for that is very high. And if the Fed is not hiking in September, practically speaking, they're realistically not going to be doing anything until December, and December is a very long time away. So I would just highlight that as another consideration around the shift in rate views.
Now, Katie, obviously, the U.S. and Canadian economies are very closely linked, so are the rates markets. In the weekly, you also changed views around Canadian rates. What are those changes and why?
Yeah. So in Canada, we still like being biased towards long duration in Canada and expect the Bank of Canada to stay on hold. But the recent data has undeniably been beating expectations, especially the labor data, which seems to show some momentum in the Canadian economy, and that's just led the market to price in more risk of near-term BOC hikes.
At the same time, though, I would argue that inflation and wage growth have seen some cooling. And as a reminder, the Canadian economy was in a technical recession at the start of this year. They have a negative output gap.
There's uncertainty driven by trade negotiations continuing to weigh on growth, likely longer term, especially with the USMCA negotiations falling through. So overall, despite the fact that we obviously have seen some meaningful shifts in the trajectory of the data in the U.S. and in the labor side of the data in Canada, I would still say that the Bank of Canada will likely be able to remain patient. And so as a result of that, we still like being long duration, especially front and belly in Canada.
Great. Thank you. Let's bring in Adarsh now for the FX perspective.
So Adarsh, you just heard Katie discuss some notable changes in rate views from the rate strategy team. How does that impact your thinking on FX and what are your key FX views at the moment? Sure.
Thank you, Mark. So very similar to Katie's views on U.S. rates, we did have a bullish U.S. dollar conviction for the third quarter. That near-term bullish dollar conviction has reduced precisely for the reasons that Katie mentioned, the FOMC meeting, the data we've had since.
We had been recommending short euro dollars since June. We closed that trade after the FOMC meeting. And at this point, I think the main question we get from clients is, is this the time to go the other way?
Is this the time to actually sell the dollar and buy euros? And at this point, I'd say we're not convinced it's the time to flip positioning. In fact, our year-end forecast for euro dollar is 1.15, which is very close to current spot levels.
So I think that kind of tells you what we feel, which is we feel quite neutral as far as the euro dollar exchange rate is concerned. It is notable that since the FOMC meeting, euro dollar has rallied a little bit, but not as much as you'd expect, given the weakness in the U.S. data that you were describing earlier. And I think there are a few reasons for this.
Firstly, look at what's happening to European gas prices. Obviously, Middle East uncertainty is pretty high. This has kept European gas prices elevated.
And certainly this is one factor that's capping euro appreciation versus the U.S. dollar. Secondly, the market has been quite bearish euro dollar. But when we look at our positioning metrics, as well as the recent FX and rate sentiment survey that we released, it looks like euro shorts have been reduced quite meaningfully and positioning is quite light heading into the summer period.
And then finally, I'd say it's difficult for the market to chase this dollar sell-off, given that we have Jackson Hole coming up, given that we have another round of jobs and inflation data in the U.S. So it's difficult for the market and for us as well to be convicted on a short dollar view right here, right now. So as far as euro dollar is concerned, I'd say we have a fairly neutral view.
We're no longer short, but we're not ready to flip long. The other key FX view I'd mentioned, you talked about Japan. We are bullish.
The Japanese yen, although, of course, we've had a large reversal since the coordinated intervention on 31st of July. I think it's safe to say that has eroded some of the credibility behind the intervention. And of course, what we flagged is there are many policy stakeholders around this coordinated intervention, and that makes the FX intent quite difficult to judge.
For now, our base case is that the U.S. and Japan are serious about pushing dollar yen lower, below 155, in our view, to sustainably alter the market sentiment. But of course, there are risks that the intent is somewhat different. Maybe they want to keep dollar yen in a 155 to 160 range and shift the policy focus to BOJ rate hikes, as you were describing earlier, including in September.
But I think either way, we do like being long yen, especially versus its low-yielding peers. And it's important to flag that the broader balance of payments for Japan is improving. For the first time, you're starting to see inflows match the structural outflows that we've been seeing from Japan for many, many years.
And that's why it was still bullish on the Japanese yen. Great. Thanks, Adarsh.
I did want to talk about how things are looking over the next few weeks. We are entering at least one of my favorite periods of every year. It's the last two weeks of August.
In the last two weeks of August, financial markets kind of just agree to put things on pause, generally speaking. It's where collectively, at least I sense the industry, all goes on holiday. And it's really sort of a unique time over the course of the year.
But these periods are not without macro events. And because we, at least on the strategy side, are going to take off the next couple of weeks, I wanted to get perspectives from Katie and Adarsh on what they're really watching going into this somewhat quiet period. So, Katie, what are the key risk events that you are keeping an eye on as you go to the beach?
Yeah, so within these dog days of summer, we have a number of data prints that we will be paying close attention to. Obviously, this morning, we got retail sales that came out in line with our economy's expectations. But going forward, we're also going to get consumer confidence, we'll get PCE, and then the labor market data and ISM releases will come in the last week of August, the start of September.
The key risks are these US events, which include FOMC minutes on August 18th and Jackson Hole on August 28th. So from a race market perspective, Jackson Hole will probably be the most important event. The theme this year is financial innovation and payments, but markets will probably focus on any signal regarding the policy outlook.
We expect any signal from site communication to generally reinforce the message that recent inflation and labor data probably provide the Fed with more room to be patient. Chair Warsh is going to speak at Jackson Hole as well. And obviously, he's been very adamant previously about not providing forward guidance.
I do think just given the market's reaction to his July press conference, which to us felt like an inflation credibility shock, that perhaps he will maybe consider changing his communication strategy. But Jackson Hole and the August minutes matter because they can either validate or challenge our new framework. If Fed officials acknowledge the softer inflation and labor backdrop and reinforce a patient stance, that would be consistent with our view of being long the belly and a steeper curve.
Conversely, the primary risk to our positioning would be any reacceleration in the economic data or renewed emphasis on further Fed tightening. But the key message, I think, for us, the second half of August is that, you know, despite that later summer liquidity, event risk will remain. That softer inflation and labor data has reduced the pressure on the Fed, but shifted risks towards, you know, lower front end rates and a steeper Treasury curve.
And Jackson Hole and the FMC minutes are likely to be important catalysts. Specific to Jackson Hole, a question I've been getting recently is, do we think Jackson Hole can change sentiments regarding the bond? How would you respond to that?
I think that the, you know, Jackson Hole tends to be focused on, you know, like I mentioned, the theme this year being financial innovation and payments, it'll be interesting to see if Warsh's speech is focused more on that theme or more on the outlook. And I think if it's more focused on the policy outlook, it would definitely be a bit of a shift in his prior, his prior communication, where he's been very, you know, very limited in his willingness to provide forward guidance. This could really, you know, have significant impact on the bond if there was more clarity on Fed's reaction function or any change in guidance around, you know, around expectations for, for near term hikes.
Look, my own personal view is that Warsh got served a dose of humble pie at the July FOMC meeting. And the FT article last week makes me think that he got the message. And if that is right, I would expect him to provide a bit more guidance on why he is confident that inflation is going to fall back to target.
And if he provides more of a roadmap, if he gives a little bit more of his own personal conviction as to why the current policy setting is right, and if that comes across as credible, I do think it can shift sentiments on the long run. Now, I'm a full believer in the 530s steepener right now. But I do think that if he reacts in a way that suggests he got the message from what the long end was telling him after the July FOMC, I do think it can shift sentiment there.
I don't think that's going to push the market into bull flattening like 530s territory, but I do think it can perhaps shift some of the very negative sentiment that exists around the long end right now. All right, Adarsh, what are the other key things that you are watching from an FX perspective as we go into the last two weeks of August? Sure, Mark, so I'd like three things outside of the U.S. risk events that were already discussed.
So Japan will remain top of mind. 160 is a very important level in Dolly Yen. So if we were to get there or above that level and we did not see any intervention, then you could get a fairly rapid move high in Dolly Yen. So watch that.
But beyond intervention, I think there are a couple of other things to watch out for. Obviously, fiscal policy is a big focus in Japan. And in August, you do have various various government departments submitting their budget plans to the government, to the government ahead of the budget for fiscal year 2027, which has to be ready by the end of the year.
So watch for any news around that. Are we seeing any signs of fiscal prudence in Japan, which has to be part and parcel of supporting the currency? And then in the background, when we talk about policy changes in Japan, it's about rate hikes, it's about fiscal policy, but it's also about will there be some pressure on domestic institutions and households to start bringing money back to Japan?
So, of course, I'm talking about the public pension funds, but also Japanese households. Sorry, the finance minister, Katayama, has talked previously about incentivizing these players to rotate from foreign assets to domestic assets. It's not something that will happen immediately, but any news on that front could be important for Japanese markets.
The second thing I'd flag is German state elections. So there's an important state election. It's happening in early September.
This is Saxony-Anhalt. The stakes are pretty high in this election because the right wing party, the AFD, is polling quite high. So watch the polls over the next couple of weeks.
It does matter for European markets in terms of fiscal risk premium, what it means for the shift to the right in a country like Germany. So it could potentially be a risk event over the next two to three weeks. And then the final one I'd mention, a bit left of field, but the Xi-Trump summit is scheduled to take place in September.
But usually before these big summits, you tend to get reports around how the preliminary discussions are going and whether they're going well or not. So watch for any reports on that front. I think the main spillover to FX markets is via the CNY.
The renminbi is actually a pretty good coincident indicator of how the US-China relation is going and particularly how kind of these Xi-Trump summits tend to go. If they're not going particularly well, then China tends to keep the currency quite stable, which is in fact what has happened over the past couple of weeks. But if it looks like the discussions are going well, then usually there tends to be some token appreciation in the RMB.
So it would be a good indicator of how these discussions are going. And if they go well, then we do think China ultimately would allow further appreciation in the RMB. Excellent.
Thank you, Adarsh. And thank you, Katie. Thanks for joining us today.
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