The US dollar fails to capitalize the hawkish Fed as markets count on a ceasefire (Daily analysis 17.03.2022)

The stock market indexes are racing upward. The oil price has had a massive turnaround and has retreated to 100 USD per barrel. Investors are turning away from the franc and the dollar, which were the most popular currencies several days ago. Together with the forint and the Czech koruna, the zloty is recovering. Hopes for a ceasefire are so vibrant that markets are unimpressed by the first US interest rate hike since 2018, which will turn into a cycle.

Polish zloty: considerable dynamics and optimistic forecasts for the euro, franc and dollar

A downward correction of the EUR/PLN would be cancelled by a return above 4.75 - a good omen for the zloty is the fact that in the first part of the week this barrier held back price increases. Conotoxia's forecasts assume that the zloty has not yet said its last word, and by mid-year, we will be paying about 4.50 PLN for euro, i.e. the same as before the invasion. The foundation of our expectations is the change of attitude by the MPC, which will raise interest rates clearly above 5% and desires lower exchange rates.

After the Russian attack, we should not forget that it was decided to exchange most of the government's currency funds from the central bank to the market. Redirecting the flow of EU funds is a structural change, which means additional, not insignificant, demand for the Polish zloty. Also, what was the Achilles' heel soon has a chance to turn into an asset. Solving the dispute between the Polish government and the European Union and unblocking financing for the National Reconstruction Plan would be an ace up the sleeve. The franc and the dollar will fall slightly more sharply than the euro: in a few months, their rates should be around 4.30 and 4.0 PLN, respectively. The GBP/PLN, which breached 5.55 yesterday, has less room to fall, in our opinion, as the pound appears to us to be a currency from the G-10 basket with solid potential. At the end of the half-year, the British currency should be slightly above 5.40 PLN.

Dollar: Federal Reserve raises rates and enters cycle

The US labour market is red-hot, and inflation even before the invasion of Ukraine was the highest in 40 years. As a result, despite the uncertainty fueled by the war in Ukraine, the Federal Reserve had no choice but to embark on a cycle of policy tightening. The Russian invasion arguably played a key role in moving rates by 25 bps.

A few weeks ago, investors speculated a more decisive hike, by 50 bps. Yesterday, one of the policymakers (James Bullard) advocated such a move, and it is very likely to take place at one of the following meetings: in May or in June. The projections of the optimal level of interest rates clearly indicate that we should expect six more hikes this year, which will push the cost of money to 2%. In the following year, the cycle will continue but at a much slower pace. Interestingly, in the long term, the optimal level of interest rates is still considered to be around 2.5% - in the long term, the optimal level of interest rates is still perceived to be around 2.%, assuming an intensification of the tightening, but not a fundamental change in the inflation profile, which will require much higher interest rates for many years.

However, no cards have been revealed regarding the future of the total balance sheet. As a result of the strong response to the pandemic crisis, it has swollen from just over 4 to almost 9 trillion USD. Such massive assets in the hands of a central bank are undesirable; their value will be limited through so-called quantitative easing. There is no doubt that this time the Fed will not wait two years or so after the first hike to start this process. The announcement of the decision in this regard can be expected no later than June.

Dollar: zloty and pound resilient, euro awaits turnaround

The dollar is not strengthening: the EUR/USD exchange rate is back above 1.10. In previous days, the US currency already had a chimeric run, but investors clinging to hopes of a ceasefire may have held off on reversing its appreciation given the approach of the historic Fed meeting. Moreover, the outlook for US monetary policy is thoroughly digested. Rising interest rates will benefit the dollar in the near term against the euro, which cannot count on an imminent normalization of policy. Optimism about the agreement between Russia and Ukraine will push the fundamentals into the background in the coming days. Clear support for the dollar would be a change in attitude towards the optimal level of interest rates in the long term.

Conotoxia's currency forecasts assume that the euro will be worth a dollar and fifteen cents in the second half of the year. At some point, the markets will start pricing in a turnaround in the European Central Bank's attitude - we expect inflation in the eurozone to be more persistent than assumed by the monetary authorities, which will translate into a tighter policy. And such moments - a sharp change in the attitude of the authorities result in the strongest reshuffling in the currency market. Let us add that the pound sterling should also be stronger than the US currency, supported by the even more hawkish Bank of England, which will most likely confirm this reputation today. After a series of six hikes, the zloty raised the reference rate to 3.5% and, thanks to the hawkish stance of the Monetary Policy Council - in contrast to the second half of last year - should be resistant to the foregone and tamed perspective of tightening in the US.