AUD: Middle East tensions, AI sell-off & softer Australian CPI all in focus

The major foreign exchange rates have remained relatively stable overnight ahead of tonight’s FOMC meeting. The biggest movers so far this week have been the Scandi currencies of the Norwegian krone and Swedish krona reflecting the sharp correction lower for crude oil prices. The Norwegian krone has been one of the G10 currencies which has benefited from the energy price shock while the Swedish krona has been hit the hardest. The recent de-escalation of military tensions between the US and Iran since the weekend has triggered temporary reversals for the Norwegian krone and Swedish krona although the sustainability of those moves has been questioned overnight by fresh military strikes. The US Central Command stated that the “Islamic Revolutionary Guard Corps forces launched multiple ballistic missiles from Iran in an attempted surprise attack on US forces in the Middle East”. The regional command also stated that US and Saudi forces conducted military strikes on Iran-backed militants in Iraq after the Islamic Revolutionary Guard corps directed 30 drone attacks against US forces in the last 72 hours. Iran’s state-run IRIB News has reported that Iran “struck and brought to a halt” three tankers transiting the Strait of Hormuz on what was called an unsafe and illegal route. The latest unfavourable developments have lifted oil prices overnight but the price of Brent remained below USD90/barrel.                   

The other main market focus ahead of the FOMC meeting has been the deepening correction lower for AI-related stocks. The Nasdaq extended its sell-off since the June peak to over 10% yesterday. A bigger correction has taken place in South Korean equities with the Kospi index falling further by 6% overnight. It extends the sell-off for the Kospi to around 40% since the peak in June, and it has now given back all of the outsized gains since April. The main trigger for further selling overnight was the release of latest earnings report from SK Hynix which has failed to meet sky-high expectations. The world’s second-largest memory-chip maker, SK Hynix, reported a 557% increase in operating profits of KRW60.54 trillion for the three months to 30^th June compared with the same period of last year. However, it was lower than the consensus estimate of JPY64.22 trillion. Sales also fell short of analyst estimates despite jumping by 257% to KRW79.3 trillion. Memory shortages did allow SK Hynix though to post record a profit margin of more than 80% for the quarter. SK Hynix executives attempted to dampen investor concerns that demand for data-centres could slow by telling them they’re signing long-term contracts with no end in sight to explosive demand. The chairman of SK Hynix expects demand to outpace supply until at least 2030. So far there has been limited spill-overs into the FX market from the correction lower for AI-related stocks. However, we did highlight in our latest FX Focus report (click here) that a deeper sell-off is one potential downside risk for the US dollar.

The Australian dollar has also been one of the beneficiaries from increased demand related to the AI buildout. The Australin dollar has weakened overnight although it was mainly triggered by the release of another softer than expected inflation report from Australia that has dampened expectations for further RBA rate hikes. Core inflation surprised to the downside for the second consecutive quarter in Q2. The trimmed mean measure of core inflation increased by 0.8%Q/Q and by an annual rate of 3.6%. It was around 0.2ppts lower than the RBA’s latest forecast from May. The softer than expected print gives RBA policymakers a better starting point for their updated economic forecasts which helps to ease pressure to hike rates further even as inflation remains above target. The probability of one final hike later this year has now fallen to around 50:50.      

EUR/CHF VS. CARRY ATTRACTIVENESS

Source: Bloomberg, Macrobond & MUFG Research

CHF: Widening ECB-SNB policy divergence is encouraging Swiss franc sell-off

The Swiss franc has continued to weaken against the EUR at the start of this week resulting in EUR/CHF hitting a fresh high overnight at 0.9332. The Swiss franc has been undermined this month by the widening yield differential between the euro area and Switzerland. ECB rate hike expectations have picked up in response to higher energy prices. The euro-zone rate market has moved to price in a higher probability of the ECB delivering two further hikes this year. Plans for at least one more hike in September appears to be in place with Bloomberg having reported that ECB officials are prepared to raise rates again in September unless the inflation outlook improves markedly.

In contrast, Bloomberg has reported this week that the SNB is set to keep rates on hold at 0.00% until the end of 2027 according to people familiar with the thinking inside the central bank. The view is mainly based on current forecast for inflation and assumes no major new shocks, and is also influenced by the Swiss franc’s recent weakening against the euro and the interest rate differential between the euro area and Switzerland. The report signals that the SNB is comfortable with the outlook for inflation. The latest forecasts presented at the June policy meeting revealed that they expect inflation to increase to only 0.8% by the end of this year. At the same time, the SNB continues to reiterate that it has an increased willingness to intervene to sell the Swiss franc to counter rapid and excessive appreciation which is currently not needed. It represents a different approach from the SNB compared to during the last energy price shock in 2022 when the SNB turned hawkish and encouraged stronger currency to dampen upside inflation risks (click here).