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The dollar won't suffer a lasting Warsh penalty, say Citi's FX strategists.
With the countdown to Kevin Warsh's first FOMC truly on, we're hearing from seasoned strategists about how they're playing the currency reaction.
Citi, one of the world's biggest prime currency dealers, says it thinks that any post-Warsh dollar weakness will be limited, while eyeing euro-dollar as a vehicle to express the view.
"Fade EUR rallies if Warsh disappoints hawks," says Daniel Tobon, strategist at Citi.
The call rests with the view "the FOMC is unlikely to deliver the hawkish surprise needed to finally break the USD out of its 12-month range. On the contrary, increasing potential for which we expect Warsh will lean into, could be an additional factor for looking past any commodity-induced inflation surprises."
As per the well-worn FX playbook, such an outcome would result in USD weakness, which Citi sees as a short-term prospect.
Beyond the initial reaction is a more nuanced view, in which the euro actually underperforms.
Tobon says:
"While we had been more tactically cautious risk assets, the combination of a potential deal, Warsh delivering a neutral message, and a successful major IPO last week could see risk stabilise and rally. In FX, that should see carry trades resume, which we prefer funding with EUR and CAD."
The euro is a preferred G10 funding currency because Eurozone interest rates remain relatively low compared with many developed-market peers.
A resurgence in carry trading - which works best in a low-volatility and confident global context - therefore tends to generate euro selling as investors borrow euros to finance purchases of higher-yielding currencies.
Citi looks to sell the ensuing euro-dollar rally towards 1.1660-1.1680 resistance.
