Dollar swoops up safe haven demand
The US dollar surged higher at the end of last week due to a combination of factors as global economic uncertainties and US debt ceiling jitters spurred some safe-haven demand, whilst still-elevated US inflation sparked scepticism about the Federal Reserve’s (Fed) year-end rate cuts. The US dollar index clipped a five-week high, with EUR/USD sagging towards $1.08, though positive equity futures point to a rise in risk appetite this morning.
The University of Michigan survey for May showed US consumer sentiment slumped to a six-month low amid rising recession fears, but long-term inflation expectations also jumped to their highest since 2011. Stagflation risks are back on the table, putting the market’s aggressive pricing of Fed rate cuts into question. The probability of a June rate hike climbed from 0% to 15% last week, whilst just over 75 basis points of rate cuts are still being priced in before year-end. We could see a readjustment of such dovish pricing which would favour dollar demand, though the Fed’s data-dependent stance means this week’s US retail sales, industrial production and housing data will be closely scrutinised. The disinflationary trend is progressing too slowly for the Fed to pivot towards easing policy before the end of the year, but weaker consumer spending and manufacturing output would suggest the quarter point increase by the Fed two weeks ago was the last of the rate-hiking cycle.
Meanwhile, President Joe Biden and congressional leaders are scheduled to meet again this week as the US draws nearer to the so-called “X date,” or when the government may go into default.
Pound slumps back below $1.25
The British pound snapped a three-week winning streak against the US dollar and ended last week back below $1.25 for the first time since mid-April as investors sought safety in the US dollar and other safe havens like the Japanese yen and Swiss franc. Against the euro, sterling recoiled sharply from a five-month high, but scraped a fourth weekly rise in a row.
GBP/USD has found some much-needed support at the 10-week moving average after suffering its biggest weekly loss since early February, and despite falling short of the 100-week moving average target neat $1.27 last week, the currency pair remains just under 4% above its 1-year average. Although interest rate differentials favour a prolonged rise in the pound, and UK recession fears have eased markedly, a bout of dollar weakness amid global risk aversion could see a short-term correction towards the 50-day moving average at $1.2364. On the data side, the Chartered Institute of Personnel Development said expected median pay settlements in the UK public sector for the coming 12 months rose to 3.3%, up from 2% in the previous three months, marking the highest level since records began in 2012. This will be a worry for Bank of England (BoE) policymakers who are already wary that strong wage rises could lead to high inflation becoming embedded.
Last Thursday, the BoE raised its key interest rate for the 12th consecutive time, taking the bank rate to 4.5%. The central bank also upgraded its inflation and growth outlook as well as wage growth expectations. The latest UK labour market data will be published tomorrow morning and should wage growth continue to surprise higher, we could see BoE rate expectation climb, possibly supporting sterling demand.
Euro’s position unwind against a hawkish ECB
The monetary divergence between the European Central Bank (ECB) and Fed, which has driven most of the euro’s strength in the last couple of months, seems to have peaked. EUR/USD just recorded its worst week since September amid tensions surrounding the US debt ceiling and weaker global macro data out of Germany and China.
After finding a 20-year low in September 2022, the euro had risen from $0.95 to $1.10 in a span of 5 months, appreciating 16% against the US dollar. Most of this strength had been driven by the economic rebound after the energy crisis and the hawkish ECB. However, the stretched positioning and already priced in rate cuts by the Fed seems to have left EUR/USD without any catalysts to push the pair meaningfully above the $1.10 mark. Last week’s sell-off should be seen as a positioning unwind, which still has to translate into a prolonged dollar recovery. For this to happen, markets would have to price out rate cuts by the Fed and the ECB would need to make good on the promise to continue tightening monetary policy.
Judging by the recent speeches of ECB Governing Council members, it seems to appear that a consensus around further rate hikes has been formed after the latest inflation print. Bundesbank president Nagel even suggested rate increases beyond the summer (September). As of now, economists polled by Bloomberg expect the ECB to raise policy rates two more times in June and July, while markets price in one last hike at the June meeting.
Dollar firms amid risk-off market conditions
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.
