US economy keeps throwing up surprises
Contrasting with the expectation for a decline, new orders for US manufactured durable goods jumped 1.7% month-over-month in May, beating forecasts for a third consecutive month. New homes sales surged to the highest level in over a year and consumer confidence hit the highest level since early 2022. The solid data dump eased recession fears, boosted risk sentiment and sent equities higher and the US dollar lower across the board.
Despite significant disinflation in the US, hopes of any rate cuts before 2024 have all but evaporated – with doubts even re-emerging about the timing of the peaks. US Treasury yields continue to edge higher as a result, mainly on the short-end though as the probability of a 25-basis point rate hike by the Federal Reserve (Fed) in July climbs to 74%. Although you might expect this development to support USD demand, it’s the positive impact on risk sentiment that is overshadowing for the time being. The strength of the recent incoming economic data means a recession as soon as the third quarter now appears less likely, but still, the probability that the US eventually falls into recession, according to the New York Fed, has jumped to 71%, the highest level since the 1980s. Moreover, the ongoing rapid tightening in bank lending standards will be a drag on the economy towards the end of the year.
Fed Chair Jerome Powel is due to speak this afternoon and given the recent data, a reiteration of a hawkish message endorsing more rate hikes could provide the US currency some much-needed support having so far this month erased over 60% of its gains made in May.
Sterling’s best start to a year since 2017?
The pound notched its biggest daily gain against the US dollar in two weeks on Tuesday, boosted by a modest return of risk appetite following upbeat economic data and wavering geopolitical risks. Against the euro though, sterling is struggling amid hawkish iterations from European Central Bank (ECB) policymakers. GBP/EUR continues to flirt with the support of an upward sloping trendline that’s been in place since mid-April.
Although markets have turned a bit hot and cold on sterling after last week’s jumbo 50 basis point rate hike by the Bank of England (BoE) that lifted rates their highest level in 15 years, the pound appears to remain on track for an over 5% gain versus the dollar in the first six months of this year. This would mark its best first-half performance since 2017, when it rose 5.65%. With BoE rate expectations pointing to a peak of 6%, the two-year UK-US yield differential has climbed to its highest in nine years, supporting sterling’s advantage. However, at some point, higher interest rates and a cost-of-living crisis will take their toll on the UK economy, and this could weigh heavily on the pound in the future.
Until consumer spending and services activity starts to roll over, amplifying recession risks, the pound may continue to strengthen though, purely based on robust global risk sentiment and a greater yield appeal. Lacking any major data releases, the focus for today will be on speeches by BoE governor Andrew Bailey and chief economist Huw Pill.
Broad euro strength dampened by data
The European inflation dynamic has changed from being primarily goods and supply chain driven to services and housing playing a larger part in explaining higher prices. This new phase could anchor inflation at higher-than-expected levels, according to Christine Lagarde. For that reason, it is unlikely that the peak rate has been reached already, according to the ECB president. Other policy makers chimed into the discussion on the terminal interest rate, with most of them echoing Lagarde’s commitment to tighten monetary policy further.
Core inflation rates remain at the center of it all. Policymakers would only consider following the Fed in pausing the tightening cycle once underlying inflation begins to retreat, according to Governing Council member Pierre Wunsch. The rollout of cheap public transport tickets last summer in Germany might make that ask a bit difficult, as economists expect core inflation to tick higher again in June to 5.5%. Policymakers have mostly ignored the fall of headline inflation, as the focus has shifted on to services inflation being pushed higher by a strong labour market and consumer. While the Eurozone did fall into a recession at the end of the first quarter, elevated price growth makes the ECB’s rate setting one-dimensional without any room for nuance to look at the macro picture.
Markets seem convinced that the ECB will manage to raise interest rates two more times by 25 basis points in July and September, pricing in a terminal rate of 4%. The repricing of rates and stocks surging following better-than-expected US data, has pushed the euro higher against most peers. EUR/USD appreciated by 0.5%, rising to $1.0960. EUR/JPY surged to a new 15-year high at ¥157.90, while EUR/CNY pushed beyond ¥7.9100 for the first time since January 2021. The euro’s broad strength from yesterday weakened a bit going into today’s session following weaker-than-expected German consumer confidence. The gauge published by GfK fell for the first time since October 2022.
Euro is proving to be an outperformer this week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 26- June 30
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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.
