Cautious optimism around debt ceiling talks
The US dollar is holding near a seven-week high today, boosted by safe-haven bets amid ongoing US debt ceiling talks and by traders paring back bets on a Federal Reserve (Fed) interest rate cut any time soon following solid US consumer spending and housing data. EUR/USD slumped to its 100-day moving average around $1.08 as a result.
All eyes remain on the US debt ceiling drama as President Joe Biden and top US congressional Republican Kevin McCarthy work towards avoiding a damaging debt default. Biden is cutting short his trip to Japan with G7 leaders as the deadline for a deal nears. Cautious optimism has boosted global stocks and weighed on Treasuries, but the dollar remains firm amid the rise in Treasury yields as a result. Meanwhile, US data this week has also supported dollar demand, with robust consumer spending and production alongside the US Housing Market Index (NAHB) rising for the fifth consecutive month, reaching the highest level since July. Markets pricing in rate cuts by the Fed worth more than 200 basis points for the next 24-months seems a bit stretched, especially amidst such strong economic data this week, which followed a survey released last week showing consumer inflation expectations rose to a five-year high.
Why might we witness a continuation of dollar strength in the short term? Because economic data suggests the Fed may have to raise rates again or at least not cut rates as aggressively as markets are pricing. More technical factors to do with investor positioning could also prompt a natural rebound. Data from the Commodity Futures Trading Commission shows investors have mounted big bets against the dollar and are now holding the biggest such position since mid-2021. This increases the risk of a dollar rally when those “short” positions are forced to be unwound.
Pound rises against euro, struggles against dollar
The stronger US dollar of late has weighed on GBP/USD, with the currency pair struggling to reclaim the $1.25 handle this week, but against the euro, the pound has shifted back above €1.15, boosted by hopes that the European Union (EU) might spare the UK over car tariffs. Productive discussions with the EU about changing trading arrangements for car manufacturing saw GBP/EUR erase its weekly losses yesterday and the currency pair now looks on track for its fifth weekly rise in a row, amounting to over 2%.
Aside from the recent Brexit-related news, surprising strength in UK inflation and growth this year have aided sterling’s surprisingly strong performance in 2023, bolstered by bets of more Bank of England (BoE) rate hikes. Whilst the most recent UK jobs report did little to alter expectations for another BoE rate hike, next week’s UK inflation report will be a key piece of the puzzle. Given market pricing of a two-in-three chance of a 25-basis point increase by the BoE in June and 40 basis points in total before the peak, there is ample room for the pound to be hit by a dovish re-pricing. A softer inflation print could do just that. Leading indicators, such as the CBI’s survey of private sector selling price expectations for the next three months, point towards inflation heading lower and, interestingly, the BoE’s inflation target of 5% by year-end looks feasible. We’ll hear from BoE Governor Andrew Bailey again today as he testifies to the Treasury Select Committee about monetary tightening.
From a technical perspective, there are mixed signals muddying the outlook for GBP/USD and whilst we expect a stronger recovery in the second part of this year, in the short-term, the path of least resistance may be lower. This negative view on sterling is also highlighted by the fact hedge funds have turned the most negative on the pound since December 2021.
Euro tests key support; Chinese data weighs
Hard economic data from Europe has been surprising much weaker than expected, and even soft data such as the ZEW survey this week, showed German financial market experts predicting an unfavourable economic situation over the next six months. The recent deterioration in economic data has put pressure on the euro and might continue to do so in the short-term.
Further clouding the economic outlook has been data coming out of China this week, which has also weighed on pro-cyclical currencies. The Chinese reopening has not held up to expectations so far, with leading indicators pointing to a slowdown in economic activity. The latest data on the second-largest economy in the world showed worse than expected numbers for new loans, imports, retail sales and industrial production. Both the official and private purchasing manager indices for the manufacturing sector have fallen into contraction in April, while the youth unemployment rate topped 20%. So, market sentiment remains weak as investors hope for stimulus from the central bank or government. But new fiscal spending or even rate cuts won’t be enough for China to save the world economy from sluggish growth this year.
Europe’s economic boost from China’s reopening has already started to wane and the outlook for the euro in the short term has turned sour, especially if EUR/USD closes below $1.08 soon. That said, the longer-term picture still points towards the euro strengthening amidst a more hawkish European Central Bank interest rate outlook.
Yen punished with US Treasuries
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: May 15-19
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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.
