USD: Geopolitics hasn’t left its mark yet
The events in Russia this weekend have had little impact on global financial markets so far. The short end of the US Treasury market saw no flight to quality (2-year yields are down just 2 basis points since Friday), Crude Oil failed to hold some very modest gains in Asia and Asian equity price movements were muted. In FX, there is little evidence of a flight to quality into the dollar or outperformance of defensive currencies such as the Japanese yen and Swiss franc. The muted response likely reflects i) a lack of clarity about what comes next following this challenge to President Putin’s authority, and ii) financial markets, already a year into the wake of the Russian invasion of Ukraine, with a stronger dollar and higher experienced energy prices.
Instead, the market is heavily focused on inflation. Both central bankers and governments have come under fire for having kept monetary and fiscal policies too loose for too long. These (or at least monetary policy) will be the hot topic at this week’s annual ECB symposium in Sintra. Many of the G7 central bank governors are in attendance and are expected to deliver a hawkish message similar to that delivered to Congress last week by Federal Reserve Chair Jerome Powell.
This means that yield curves continue to appear to be heavily inverted as investors assess the depth of the looming recession and that the dollar will remain strong against these currencies in the absence of monetary protection – meaning USD/JPY remains in demand. In addition to Powell’s commentary in Sintra on Wednesday, the US highlight this week will be the release of May’s PCE core inflation data. This will be released on Friday. Another high reading for core inflation, forecast to come in at 0.4% mom, suggests the Fed’s hawkish stance must not be eased.
DXY is likely to recover in the 102.00-103.00 range this week while USD/JPY is likely to approach the 145 intervention zone.
Chris Turner
EUR: German IFO may keep euro subdued
On Friday, PMIs were weak across Europe, with the services sector worryingly slipping into the already prevailing gloomy sentiment in manufacturing. This dataset has dropped the EUR/USD rate by around 50 pips at the time of publication. Today’s June IFO in Germany could also surprise on the downside and trigger a further slide in EUR/USD back below 1.0900.
On the surface, the narrative that central bankers need to keep higher rates longer does not bode well for the pro-cyclical euro. However, the hawkish ECB has provided some protection against high US rates and has pushed EUR/USD back above 1.09 – it will also reiterate expectations of at least two more rate hikes of 25 basis points (in July and September). and may resist some of the moderate easing expected in 2024.
This environment tends to favor a continuation of a 1.0850-1.1000 range for EUR/USD and the Goldilocks soft landing/softer Fed policy scenario appears to be further delayed.
Elsewhere this week, the Riksbank is expected to hold a rate meeting on Thursday. Unless there is a restrictive rate hike, EUR/SEK will climb back above 11.80.
Chris Turner
GBP: There is no resistance to interest rates above 6% this week
There is much debate in the financial press about central bankers seeing the ‘simple’ fall in headline inflation due to the base effect. But now they face the difficult task of bringing core inflation down from around 5% – or 7% in the Bank of England’s case. In this environment, we should not expect any opposition from BoE officials to setting interest rates above 6% early next year. Likewise, we expect the government not to back down on mortgage rate easing, which would only complicate the BoE’s job.
EUR/GBP fell on last Friday’s PMI decline in the euro zone. Despite fears of a UK hard landing, we stand by the initial views we expressed in our recent BoE reaction post. Namely, that a sharply inverted yield curve is likely to trump fears of a hard landing and that sterling is holding onto recent gains for now.
This week’s UK calendar is dominated by BoE speakers, with Wednesday likely to be the key Sintra event for BoE Governor Andrew Bailey. EUR/GBP can drop back to 0.8520 this week while GBP/USD should find bids below 1.27.
Chris Turner
JPY: USD/JPY nearing intervention
The strong dollar environment keeps USD/JPY higher and nearing the 145 area where the Japanese authorities sold FX last September. True to their beliefs, Tokyo’s top financial officials are working through their verbal intervention manual and seem only a few steps away from pulling the trigger.
Japan’s FX interventions last fall were timely as they came just before US inflation eased and a strong dollar reversed. However, the risk of intervention now is that US inflation remains stubborn and Tokyo gets locked in a long battle against USD/JPY in the 145/150 area. While we expect USD/JPY to fall later this year due to a reversal in the dollar, in the coming month we can see a sharp rise in USD/JPY in a 140-145 range, indicating short-term volatility the USD/JPY options is priced a bit too low.
Chris Turner
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