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Surging energy prices driving FX

USD - US Dollar

Surging energy prices remain the top story in financial markets right now. Brent is trading close to $83/bl as OPEC+ plays it steady on supply increases and gas prices continue to surge as Asia and Europe fight over gas shipments. Fears of a cold winter in the northern hemisphere and historically low gas inventories, especially in the UK, leave the gas market very tight.

How central banks respond to this energy price spike will be a key driver of FX rates over the coming months. We know that the US economy is at the forefront of closing output gaps and that the Fed is likely to take its foot off the monetary accelerator over coming quarters. The Fed's relaxed stance may, however, becoming into question. The Fed frequently tells us that despite welcome growth and employment trends and 5%+ inflation, inflation expectations remain well-anchored. We are also starting to see the US yield curve steepen again backed by a hawkish set of Dot Plots at its September meeting. Add in any strong employment data and market expectations may swing towards Fed projections of a steep three-year tightening cycle starting next year. Look out for ADP data today. Any upside surprise to the 430k consensus figure could lift short-term US rates and the dollar.

CAD - Canadian Dollar

USD/CAD opened back above 1.2620 yesterday but then proceeded to drift lower throughout the session. Petro FX has certainly benefitted from the move higher in Energy prices as the feed through to Terms of trade etc. should be supportive for the currency. September PMI’s have shown tentative signs of improvement and if this remains the case, we could well be at the start of a decent move higher in CAD. The currency remains firmly driven by the commodities backdrop which should remain fairly supportive in the weeks ahead with limited signs that the global energy crunch will be resolved soon. However, we’ve seen in recent days a clearer risk-off reaction in equity markets to the economic risks posed by energy shortages and we may soon reach a point where the CAD begins to trade more closely with the downbeat mood in stocks than with the continued climb in commodity prices. USD/CAD downside looks limited to the 1.25 mark in the short-run with further losses to 1.24 likely to see dollar buying.

EUR - Euro

While the ECB may be welcoming the lowest levels of the trade-weighted Euro since February 2020, the ECB is leaving European businesses vulnerable to the energy price surge. The ECB's stance is at complete odds with their Chinese counterparts, who are engineering a stronger Renminbi to secure strategic commodity imports as cheaply as possible. This divergence in policy has seen EUR/CNY drop 7% this year, with no sign of this trend changing anytime soon. Indeed, it may accelerate if the dollar breaks higher - which seems the risk over coming months. The recent period of EUR/USD consolidation is likely to continue and possibly target 1.1500.

GBP - British Pound

Despite the growing narrative that the UK economy is heading back to the 70s, GBP is performing quite well – GBP/USD is clinging on above 1.36. Driving that support is the view that the BoE has said it is prepared to tighten monetary policy over its forecast cycle. Higher energy prices are directly feeding into BoE tightening expectations and supporting the pound. Even though that tightening may ultimately be a policy mistake it looks far too early for that to hit GBP.

Most expect the GBP/USD to stall at the 1.3650 area while a stronger dollar may drag the pair back toward 1.34 and potentially 1.32.

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