US inflation remains stubbornly high. With core prices rising at an accelerated pace of 0.5% in February, terminal pricing has moved higher. The repricing in terminal has hit CHF and JPY right off the bat, but the move is set to be short-lived, economists at TD Securities report.
Market will place more weighting on financial stability over price stability for now
“Consumer price inflation matched expectations in February, with headline CPI advancing at a firm 0.4% MoM pace. However, the real news was in the core segment, with prices there accelerating to 0.5% m/m.”
“Importantly, the firmer core CPI reading reflected another robust m/m increase in the services segment, which saw sticky shelter prices as the main culprit. We also expect goods inflation to turn positive again in the near term, adding to upside risks for core price dynamics.”
“A stronger read on core has helped to reprice terminal higher, weighing mostly on CHF and JPY given they are most sensitive to this market. That said, we think markets may place more weight on financial over price stability, which may help to cap terminal rate pricing and eventually fade the dip.”
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Investors in the foreign exchange market have recently been experiencing periods of intense volatility when it comes to major currency pairs such as the United States dollar against the Swiss franc (USD/CHF) and the United States dollar against the Japanese yen (USD/JPY). Despite the occasional pump of activity, market analysts from TDS have concluded that these “pops” in activity are unlikely to become sustained trends.
Examining the fundamental drivers of these currency pairs sheds light on this assertion. From an economic perspective, both the Swiss franc and the Japanese yen are seen as safe haven currencies, which investors tend to flock towards during times of uncertainty. This is especially true during the global financial crisis and other economic downturns. As a result, when there seems to be a period of stability, or news of a global economic recovery in the near future, investors move away from these two safe haven currencies, which causes the given currency pairs to jump up in value temporarily.
However, TDS analysts point out that these spikes of activity in USD/CHF and USD/JPY are unlikely to last for long. This is mainly due to the higher liquidity of the US dollar and the limited amount of Swiss franc and Japanese yen that are available in the market. This means that once the liquidity has been temporarily exhausted, the USD/CHF and USD/JPY will slowly move back towards more traditional levels.
The conclusion from TDS is that “pops” of activity in these two currency pairs will likely fade over time. While shorter-term traders may be able to benefit from these temporary spikes in liquidity, investors should remain aware that these are unlikely to become established trends, and take appropriate steps to protect their portfolios.