Dollar wobbles after debt ceiling setback
The US dollar is trading modestly weaker this morning following a surprise breakdown in US debt ceiling negotiations and after Federal Reserve (Fed) Chair Jerome Powell indicated a preference to slow rate hikes. EUR/USD is trading back above $1.08 after falling to an eight-week low near $1.0750 last week, whilst GBP/USD has rebounded off its 50-day moving average near $1.24.
Despite rising for two weeks on the bounce, the dollar index is sliding for the second consecutive session as traders cautiously await updates from the US debt ceiling negotiations, while continuing to assess the outlook for Fed monetary policy. President Joe Biden and House Speaker Kevin McCarthy are set to continue discussions today, as Treasury Secretary Janet Yellen repeatedly warns that the US could default on its debt as early as June 1 if a deal to raise the debt ceiling is not achieved. The dollar has mostly reacted positively to the debt ceiling progress though and if we see it resolved this week, the US currency could remain supported. The Fed outlook remains critical though and amid the market quietly reducing its 2023 cumulative rate cuts from 100 basis points to 45 basis points, the dollar could gain more ground, especially if those rate-cut bets decrease further.
Markets are currently betting that the Fed will pause its historic tightening campaign next month but whether it will pivot towards cutting will depend on the economic data as investors look ahead to this week’s flash industry PMIs, a second reading for first quarter GDP and the personal consumption expenditure inflation gauge.
Sterling mixed as inflation looms
Flash PMIs tomorrow are expected to show the robust UK services sector continues to support UK economic activity. With recession fears receding and UK interest rates expected higher than US rates at the end of the year, the pound should remain relatively appealing. That said, stubborn inflation will continue to test the Bank of England and the latest inflation readings will be published on Wednesday, which could prove a key trading point for sterling.
UK headline inflation remains above 10% and above most advanced economies, but we do expect quite a big slide in this month’s print due to base effects of energy prices, whilst leading indicators are also pointing south – such as the CBI’s selling price expectations, which leads headline CPI by about 5 months. If we do see inflation cool off, although this is a good thing for the UK economy, it also means that UK interest rate expectations might ease back as well, which may weigh on the pound’s yield appeal.
GBP/USD endured its second weekly loss in a row last week, is over 2% lower than its recent high and 1% lower for the month. GBP/EUR is flirting with the €1.15 handle after clinching five consecutive weekly rises as European economic data continues to disappoint.
Euro struggling as recession fears rise
Hard economic data from Europe has been surprising much weaker than expected, and even soft data, such as the ZEW surveys last week, are pointing towards a deterioration in European economic expectations. This has weighed on the euro of late as investors brace for a raft of PMIs surveys tomorrow and German business expectations on Wednesday.
Amid the recent string of poor data, we could see these important economic activity and sentiment surveys disappoint, or at least highlight the slowdown in growth sentiment in the Eurozone. Meanwhile, hawkish comments from European Central Bank (ECB) officials continue to be overshadowed by increasing recession fears. As such, the peak in the monetary policy divergence between the (hawkish) ECB and (dovish) Fed seems to have coincided with EUR/USD reaching a local top just short of $1.11.
The balance of risks appears tilted to the downside for EUR/USD in the short-term, especially given the overstretched position of positive bets on the euro. Therefore, we can’t exclude a fall to sub-$1.07 in the near-term, which could also allow GBP/EUR to stretch beyond €1.16.
Yen punished as dollar prospers
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: May 22-26
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
