Caution: Trends in the Foreign Exchange Market

The recent themes in the foreign exchange market continued last week. On the one hand, the dollar-bloc currencies and Norwegian krona trended higher, while the euro, and especially the yen, traded heavier. On the other hand, although some critics argued that the Fed's 25 bp rate hike earlier this month was too timid, the Fed is signaling it could accelerate the pace. The interest rate adjustment continued in dramatic fashion.

The Fed funds futures imply almost a 77% chance of a 50 bp move at the next meeting (May 4). The general resilience of the US economy, the tight labor market (with weekly initial jobless claims falling to new lows since the late 1960s) and upticks in the flash PMI may embolden the Federal Reserve. The two-year note yield has risen by 50 bp since Russia invaded Ukraine, and it is not done. The consensus that appears to be developing at the Fed favors a march toward neutrality, seen in 2.25%-2.50% by the vast majority of Fed officials. The two-year note yield is near 2.2%, up from a little less than 0.75% at the end of last year. More than half of the Fed officials and economists think the target rate will have to rise above neutral to counter the inflationary pressures.

A few trends in the foreign exchange market are worth noting. First the yen's weakness. The dollar has risen in 13 of the past 15 sessions against the yen. The rise in US yields and the lack of official resistance appear to have spurred and sustained the move. BOJ's Kuroda was still finding good things to say about the yen's slide ahead of the weekend. Second, the dollar bloc is on fire. The Canadian dollar has strengthened for nine consecutive sessions and 13 of the past 14. Rising commodity prices, the reduction of the US premium at the short-end, and the policy mix, following the Liberal-NDP pace, lend support to the Canadian dollar. The S&P 500 has advanced in seven of the past nine sessions, and this proxy for risk appetites underpinned the Loonie. The Australian dollar has rallied in 10 of the past 13 sessions. Its 3.5% appreciation this month leads the majors. The New Zealand dollar's advance may not be as impressive, but its 2.8% gain against the greenback puts it in second place this month.