The euro sinks as Russia announces mobilization, and the Fed pushes the pedal to the metal (Daily analysis 22.09.2022)

The Federal Reserve restrained itself from moving by a whole percentage point, repeating the 75 basis point move for the third consecutive time, but at the same time reaffirmed its hawkish stance and announced more hikes. This brings up a familiar trading picture: when the dollar gains, market indexes go below in red, the euro loses, and emerging markets are in trouble.

The single currency sets new lows against both the dollar and the franc. The US dollar against the euro and the entire basket of the main currencies is the strongest in 20 years.

Fed policy as not the only USD asset

The dollar benefits not only from the determination of its home central bank to combat price increases. The US's position as the world's leading gas and oil producer provides the world's largest economy with greater resilience to an energy crisis and protects it from a negative balance of payments consequences and a worsening international trade position.

The USD has remained the primary option of investors for months, and the loss of this position will have to be linked to an improvement in the outlook for other currencies, mainly the euro.

The gas crisis and deep recession threatening the Old Continent make it hard not to be sceptical about the prospects for the single currency. The heating season has not yet begun in earnest, so it is difficult to expect a rapid change in attitude. The breakdown of the downward trend in the EUR/USD quotations, which would signal the end of the dollar's dominance, will only be possible once the exchange rate returns above 1.02. Still, this is a very distant prospect at the moment.

The Federal Reserve will not stop

There is a clear message from the US central bank: suppressing persistent inflation is the supreme goal, even at the cost of slowing economic growth. The red-hot US labour market, where employment is higher than before the pandemic broke out and there are roughly two vacancies per job seeker, demands further decisive tightening. According to policymakers, any thoughts of rate cuts are prevented by inflation, which will return to its target very reluctantly. Getting it under control may prove impossible without a rising unemployment rate.

Therefore, the Federal Reserve's further decisive steps aimed at cooling demand are to be expected. Decisions will depend on the information coming out of the US economy. Still, for the time being, the baseline scenario should be another 75 basis point hike at the beginning of November. After that, the pace of tightening may be reduced. The US interest rate hike cycle may end at 4.6%, and the dollar will remain attractive until the US economy weakens and inflation slows down.

Euro hits a record low also against the franc

On Thursday, September 22, the Swiss National Bank raised interest rates by 75 basis points to 0.25%. Therefore, the era of the negative cost of money, which had lasted since the end of 2014, came to an end. Even moments before the Swiss Central Bank's decision, the euro exchange rate breached the 0.95 CHF level for the first time in history. Although the franc was clearly depreciating immediately after the decision, it is difficult to count that the SNB's policy suddenly became a crutch for the Swiss currency and pushed the EUR/CHF quotations from their lows towards the parity that was broken in June. The quotations have settled a few per cent below this barrier, and there are no signs that this will change.

In consequence, a strong fall in the Swiss franc in the coming weeks seems unlikely. If the CHF is to go below in red, it will be due to improved sentiment on global markets and the fading of global capital's concerns over the situation in Ukraine. This year, a return of the EUR/CHF above 1.0 is doubtful, even in the most optimistic scenarios.

The SNB copies the ECB's hike

The fate of Swiss monetary policy is inseparably linked to the steps of the European Central Bank. The Swiss monetary authorities began to care about the franc's strength this year. This radical change resulted in a shocking rate hike in June and an advanced start to the cycle compared to the ECB. As the Swiss made the first move and the franc remains record high against the euro, harsher measures than a 75 basis point hike reflecting the ECB's latest move proved unnecessary at today's meeting.

However, in Switzerland, further strong rate moves or even rate changes between scheduled meetings cannot be ruled out definitely. Seeing that the SNB will not miss any opportunity, investors will resolve any doubts in favour of the franc by pricing in more aggressive tightening. The European Central Bank aims to end the year with the deposit rate at 2%, and the Swiss monetary authorities will not want to stay too far behind, as a very strong widening of the rate differential over time would work against the franc.