Market volatility continued to grind higher in May as markets switched between pricing a more aggressive implied policy path for the Federal Reserve and factoring in lower growth expectations and higher recession risks.
At the start of May, hawkish Fed pricing caused most of the damage in the cross-asset space as terminal rates rose, pushing the 10-year Treasury yield to a multi-year high of 3.2%. Rising US yields sent US equity indices hurtling toward a technical bear market, while the combination of higher yields and lower equities globally prompted inflows into the US dollar.
The most newsworthy event in FX markets during this period was the collapse in EURUSD.
The single currency touched multi-year lows of 1.0350, sparking debate that the pair could touch parity for the first time in two decades. Outside of the G10 space, the Chinese yuan also felt the pressure from rising US yields, but this wasn’t the only driver of CNY depreciation. Lower growth expectations in China due to prolonged lockdown measures also sparked pricing of looser monetary policy in China, meaning both legs of the USDCNY yield differential were moving toward each other. The narrowing yield differentials and risk-off tone sent USDCNY skyrocketing from 6.6 to over 6.8, until pushback from the PBOC combined with optimism about China’s post-lockdown reopening of major cities to push the currency pair back below our more conservative month-end estimate of 6.7.
The shifting structural parameters in markets meant FX forecasts specifically had short shelf lives. This resulted in still wider-than-usual forecast errors over the course of the month. Despite this, our near-term forecasts for USDCNY, AUDUSD and EURCHF continued to rest within the top-10 for the third consecutive month.
On a medium-term basis, our continued expectation of TRY depreciation and a recovery in the South African rand resulted in 3-month rankings of 4th and 9th respectively. Back within the G10, our structural calls on EUR-crosses yielded the best results.
Simon Harvey, Head of FX Analysis
Jay Zhao-Murray, FX Market Analyst
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