Dollar braces for big US data week
Financial markets finished last week on a strong note after the US PCE inflation number came in below expectations and boosted hopes that central banks were winning the war on inflation. The US personal consumption and expenditure reading (PCE) – the Federal Reserve’s (Fed) preferred measure of inflation – saw the headline annualised number fall from 4.4% in April to 3.8% in May. The core number fell less, from 4.7% to 4.6%.
The month of June saw the US dollar weaken against all G10 currencies except for the Japanese yen, but some recent hawkish comments by Fed Chair Jerome Powell at the Sintra central bank symposium last week, resulted in a rise in US interest rate expectations and supported the dollar. Crucially, markets are now actively considering the option of two more rate hikes by the Fed, despite the softer inflation report on Friday. This week might start a little quieter amidst reduced flows due to the Independence Day holiday in the US. However, US data is in abundance throughout and market participants will assess the probability of a September hike now that a July increase seems like a done deal. Today, the ISM manufacturing index will be in the spotlight, it’s been in contraction for seven months in a row and this week’s report looks set to make it eight consecutive months of contraction. Greater focus will likely be on the services survey released on Thursday, which is still in expansion, but barely.
We’ll also be closely following the employment sub-indices, along with the job opening data and the ADP private payrolls before Friday’s key event – the non-farm payrolls print. The dollar might find more support this week if markets see more reasons in the data to gradually align with the more hawkish dot plot projections, however if the manufacturing recession is anything to go by, US jobs data might come in softer than expected.
Yields support pound, but positioning stretched
Sterling rose back above $1.27 last Friday to end June over 2% higher against the US dollar, boosted by higher UK bond yields as markets price UK interest rates breaching 6%. Speculative positioning suggests bullish bets on sterling appreciating are becoming more and more stretched though, potentially limiting much more upside traction.
With UK services inflation climbing to fresh cycle highs, markets are pricing in more than 100 basis points of further tightening by the Bank of England (BoE). In contrast, markets expect other major central banks to be nearer their rate peaks. Higher relative yields tend to boost a country’s currency by making fixed income investments there look more attractive. The UK two-year yield, which is particularly sensitive to interest rate expectations, jumped by just under a percentage point in June – the biggest rise since the mini-budget chaos last September. Although sterling is recording its best start to a year in over five years, the outlook could be bumpy from here as traders weigh up the possibility of the BoE forcing the UK economy into recession to try and tame sticky inflation.
At the same time, the latest statistics published by the Commodity Futures Trading Commission revealed that GBP long positions (betting on sterling appreciating) rose to 51,994 contracts in the week ended June 27 – equalling the largest net long position since July 2014. Although this highlights market sentiment is GBP positive, it might also restrict the UK currency from climbing much higher.
German yield curve inversion deepens
Inflation in the Eurozone continued to moderate, falling from 6.1% to 5.5% in June, and reaching the lowest level since January 2022. However, the fall of headline inflation has been taken with a grain of salt as core rates stayed above the 5% mark for the ninth consecutive month. While the normalization of supply chains and falling commodity prices have put downward pressure on price growth, the fear of sticky underlying inflation might push the European Central Bank to do more tightening in the future.
That is also the insight investors took away from the week long Monetary Policy Forum in Sintra, hosted by the ECB. The event gave policymakers the opportunity to clarify their views and, in this case, underline the need for more hikes to come. Markets expect the central bank to increase the deposit rate two more times in July and September. However, with policy rates already stands at a 22-year high, some members of the Governing Council did push back against pre-committing to any moves beyond July.
European yields on the front end have risen in recent weeks in reaction to the hawkish rhetoric coming from central bankers across the world. Still, with Germany in recession and leading economic indicators not promising any surprise summer recovery, longer dated bonds have been slow to react to monetary policy. This has led the German yield curve – different between the 10-year and 2-year yield – to the most negative level since the 1990s with an inversion of 81 basis points. More than 88% of yield curve variation are now inverted, signalling a weak economic outlook. EUR/USD is positioned slightly below $1.09 with most catalysts coming out of the US this week.
Rising US Treasury yields are supporting USD
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: July 3 – July 7
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