US recession postponed, yields surge
Another series of better-than-expected macro data out of the US has strengthened the higher for longer narrative and continues to support further tightening by the Federal Reserve (Fed). The US dollar has meanwhile finally started benefiting from these positive data surprises, with EUR/USD falling well below $1.09 again.
This week’s surprisingly strong housing, consumer and durable goods data has seen the Citi surprise index for the US jump higher again, increasing the macro divergence with the Eurozone. The euro had been pretty unaffected by weaker German macro data so far, confirming the thesis that overall risk sentiment and monetary policy have been more important than the regional growth story. However, yesterday’s upside revision of GDP for Q1 from 1.3% to 2% was too strong for markets to ignore, driving up all yields on the shorter end and investors pushing out their bets for the first rate cut by the Fed to March 2024. Pressure was added to markets following the release of initial jobless claims, showing how fewer people than expected applied for government support in the week ending June 17.
This sets us up for the release of the Personal Consumption Expenditure Index, the Fed’s favorite inflation indicator, as the highlight of the week. With the one-year government bond yield reaching new highs at 5.42%, and the benchmark two-year yield approaching 16-year highs, any data surprise will create volatility across markets. Economists are expecting inflation to come in at 4.7% in May, unchanged from the month before. The data point will not only dominate the end of the week but will shape how markets might go into the next one, with the ISM purchasing managers indices for June coming up.
Pound falters after UK data
The pound is trading slightly weaker across the board this morning after a mixed bag of UK economic data but should garner support from implied short-dated yields over 5%. GBP/USD continues to grapple with $1.26, on track for a 1.4% monthly rise, whilst GBP/EUR flirts with €1.16, after hitting nine-month highs above €1.17 earlier in the month.
This morning, data showed Britain’s economic growth was confirmed at 0.1% in the first quarter of 2023, unchanged from the previous three-month period, supported by strong business investment. Nationwide Building Society also published housing data today, which showed despite an unexpected rise in UK house prices in June, the pace of decline on an annual basis has stepped up to its fastest since 2009. After recent UK inflation readings have repeatedly surprised to the upside, it has prompted investors to bet that the Bank of England (BoE) will now be forced to rate its key interest rate above 6%. Borrowers are facing a steep rise in mortgage costs as a result, and this is likely to exert a significant drag on housing market activity in the near future. Why has the UK avoided recession so far though? One potential reason is the sheer volume of excess savings accumulated by UK households during the pandemic, which continues to be drawn down and spent particularly on services rather than goods. This is fuelling services inflation, which is keeping the pressure on the BoE to keep hiking rates.
Markets are growing concerned that further BoE hikes will lead to a deep and long recession in the UK though. This will be a limiting factor for the pound, which currently remains the best-performing G10 currency year-to-date, largely thanks to its attractive yield appeal.
Euro softens before EZ inflation
Market participants analysed mixed consumer price inflation data from Europe’s largest economies ahead of today’s Eurozone-wide figure. Inflation in Germany accelerated to 6.4% in June, up from the 14-month low recorded in May, while consumer prices in Italy and Spain rose at a slower pace. EUR/USD is hovering below its 50-day moving average around $1.0870, which has acted as support over the past couple of weeks. Will it give way this week? The plunge in German import prices hasn’t helped.
Germany’s 10-year bond yield rose towards 2.4%, reaching its highest level since mid-June following the rise in German inflation. Although the fall in headline inflation in both Spain and Italy will be welcomed by European Central Bank (ECB) policymakers, the core inflation rates in all three countries have converged and remain persistently high. Meanwhile, we also saw the economic sentiment indicator in the Eurozone decline for a second consecutive month and to its lowest reading since last November, whilst on the price front, the consumer inflation expectations index dropped to the lowest since March 2016, while the gauge for selling price expectations among manufacturers decreased to the lowest level since November 2020.
It has been well telegraphed by ECB officials that they will raise interest rates again in July, so the euro hasn’t profited from the hawkish tones coming from Sintra this week. Looking further out to the September meeting, although markets currently expect another 25-basis point hike, the plethora of data between now and then could sway those bets. Whilst we expect an uptick in Eurozone inflation today, the disinflationary process should start speeding up later this year.
Rising US Treasury yields are supporting USD
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 26- June 30
Have a question? [email protected]
*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.
