What Happened

• The Buck took back May losses and then some, totaling a 2.7% upward move per the Bloomberg Dollar Spot Index (BDXY).
• Markets plummeted with fears of recession as a debate over the effects of tighter monetary policy have fomented instability.
• Divergence in monetary policy has weakened JPY to a 24-year low against the greenback.
• Russian Ruble (RUB) was the only gainer over the buck as natural gas spiked and war advances.
• Euro dropped to its weakest point since 2002 as the energy crisis kept economy stagnant.

GreenShootsFX’s View

• Optimism over economic growth fading as challenges of first half of the year dampened the recovery of 2021.
• Euro prospects for appreciation could improve if European Central Bank materializes interest rates hikes.
• Mexican Peso swings will remain commonplace as commodities and equities stay on an uncertain path.
• China and the U.S. are said to be making attempts to mend trade relations, ease tariffs leveled during the last administration.

In Focus

• The ups and downs are indicative of a clueless world embedded in problems.
• The resilience of markets is being tested as the war has wounded the interdependence of the globalized system.
• A lack of consensus during the pandemic and over the war exacerbated divisive problems causing a larger divide and gap in wealth.
• Global equities are down -18.0% for the year, with S&P 500 concluding its worst first half of any year since 1970.
• The World Bank downgraded its growth outlook and forecasted years of ongoing “stagflation”.

In Depth

Doubt overwhelms markets, rewarding the safe-haven buck for now. A lack of clarity over war and the supply chain characterized the first half of the year.

China gave signs of waking up last month, but the rest of the world remains in foggy territory. A time of energy chaos paints a dire picture for the world’s economy as inflationary pressures cast a rough outlook for the remainder of the year. Following years of easy lending and zero interest rates, inflation has pushed central banks, except the Bank of Japan, to hike interest rates that are cooling down borrowing as well as expansion.

A debate over whether the U.S. economy can withstand the Fed’s rounds of hiking has gotten hold of markets. The negative side is winning its argument that stocks are overvalued, economic enthusiasm will be difficult to restore, and there is only room for things to worsen. Naturally, this helps the greenback, but could the tide turn?

When the Federal Open Market Committee met on June 15th, currency markets surprisingly punished the buck after a 75-basis-points increment to the Federal Funds Rate (now at 1.75%). The reason for the drop was simply in the way that Fed Chairman Jerome Powell explained the move: this is a necessary occurrence that may not repeat itself.

While officials agreed that inflationary growth needs to be contended seriously and aggressively now, Powell said they saw no need to maintain this pace of hiking in upcoming meetings.

Nevertheless, the markets are convinced that the Fed will not deviate from 50-bps moves going forward. Realizing that the country is dealing with its worst inflation in 40 years, traders now see no excuse for the Fed to turn around and change its mind about its hawkish implementation.

Powell reinforced this during a special ECB Forum on Central Banking in Sintra, Portugal, where he committed to the Fed’s mentality while professing that the economy could survive the increase in borrowing costs.

Meanwhile, the G-7 agreed in their June gathering that their alliance with Ukraine in this time of conflict and despair will continue and committed billions to helping down the line for rebuilding. More importantly, leaders basically admitted that the current situation is undesirable with Russian attacks on civilians taking place and their cash coffers much larger as the demand for payment in Rubles (RUB) for traded commodities has been abided by many nations, including large ones that we do business with such as India and China.

Oil, natural gas, and even grain taken during the invasion have been successfully exchanged for cash to further finance the efforts. Financial restrictions have not constrained Russia’s ability to wage war.

Regardless, recent assessments have determined that the economic slump from Russian aggression has wiped away 15 years of gains. As far as Europe is concerned, the ban on oil imports remains, natural gas has increased in price by over 700.0% (not a typo), and coal mines are scheduled for re-opening.

On the Euro front, it is clear that the effects of conflict are negating celebration in other areas. As proof of the European project’s ability to solve financial problems, Greece finished paying off its debts after years of combatting concerns of defaulting on its debt obligations. “Grexit” did not happen, but now the concern is over Italy, with a higher GDP-to-debt ratio after the pandemic that makes it more indebted than the region as a whole.

In Europe, yields vary from country to country, regardless of the use of the common currency, and economists are worried that the gap in bond yields between Euro-zone economies is getting to a point where you need to address fragmentation, unsustainable differences in credit and debt spreads.

As a result, ECB President Christine Lagarde and officials had an emergency meeting and produced a statement in which they addressed that “The pandemic has left lasting vulnerabilities in the Euro-area economy…” which they hope to alleviate through reinvesting redemptions from the Pandemic Emergency Purchase Programme (PEPP).

Italy, the EU’s third-largest economy, is again under the spotlight as its 10-year bond declined by half of its value in just six months, alarming borrowers and monetary policymakers. It is important to recall that the nation struggled in a big way when COVID-19 first arrived and that it formed a fragile government coalition under Prime Minister Mario Draghi. Luigi Di Maio, the leader of the Five Star Movement and key to giving Draghi legislative leverage, suddenly quit only making matters more difficult.

We foresee a tough Summer ahead as Brexit trade issues resurface following legal action mid-month from the EU against Britain’s disregard for parts of the Northern Ireland protocol. Additionally, current Primer Minister Boris Johnson has allowed ministers to override parts of the Brexit deal as they see fit.

However, his tenure seems threatened with ministers in his cabinet resigning after scandals have tested the Tories’ patience with their controversial leader. For now, the buck looks the steadiest asset to hold amid woeful short-term expectations. War will need to cease to flip it all.