US dollar strays from 15-month low
Last week’s US inflation data fuelled investors’ bets that the Federal Reserve (Fed) is close to the end of its rate hike cycle, and the US dollar suffered its biggest weekly decline since November 2022. USD selling pressure has eased this week though and the dollar has made a marginal recovery across the board, pulling away from 15-month lows, as incoming data suggests disinflation may well be a more widespread dynamic among major economies.
As disinflationary forces gather momentum, traders are betting that the Fed will deliver its final interest rate hike this month and cut rates through 2024. Conditional upon a 25-basis point hike being delivered next week, they are pencilling in 150 basis points worth of rate cuts by the end of next year. The US dollar outlook is likely to remain strictly tied to Fed rate expectations, so unless the Fed pushes back against market pricing, the weaker dollar story should continue through the second half the year and into next. Moreover, despite many leading indicators pointing to a looming recession, many economies, including the US, have so far defied expectations of a sharp economic downturn as a result of tighter monetary policy. We’ve seen a mixed bag of data this week, but the overall macroeconomic picture remains one of resilience and strength, but because investors are more focussed on the impact of falling inflation on interest rate expectations, the US dollar struggled to benefit until we saw evidence of disinflation elsewhere (UK).
The tight range seen in EUR/USD over recent trading sessions comes amidst clearly overbought conditions in the short-term and some weakness may unravel from here. The longer-term EUR/USD outlook remains positive thanks to the upward sloping trend of its 200-day moving average, however a persistently better US economic backdrop versus Europe remains a key downside risk. The Philadelphia Fed index and existing home sales data will be watched along with jobless claims today.
Pound loses top spot after inflation
Sterling is still up nearly 7% against the US dollar this year, but after the below-forecast UK inflation print published yesterday, the Swiss franc has reclaimed the top spot as the best-performing major currency year-to-date. The pound suffered its worst one-day fall since March because investors subsequently pared back bets on a further sharp rise in UK interest rates.
Although UK inflation is still the highest amongst advanced economies, the easing of both core and services inflation (closely followed by the Bank of England (BoE), sent two-year gilt yields, a good proxy of interest rates, around a quarter of a percentage point lower – the most since March. Widening interest-rate differentials in the pound’s favour have been a big catalyst for the UK currency in 2023, but with the gap shrinking following the rate repricing after the inflation print, this positive factor may have peaked. Earlier this month, markets were forecasting that the BoE would put the UK’s key interest rate up to 6.5%. Now, markets think that the BoE rate will peak at less than 6%. This is what’s driving sterling and if we see a further repricing lower, expect the pound to continue falling as a result. We have UK consumer confidence and retail sales data due early Friday morning and weaker-than-expected prints will add to sterling’s woes.
GBP/USD found some much-needed support at its 200-week moving average just under $1.29 but closed below its 10-day moving average and has suffered four days of successive losses after reaching a 16-month peak last week. GBP/EUR is also on the backfoot, toying with the €1.15 handle and is now over 1% below its two-year average rate.
EUR/USD hovering around $1.12
With US data and the Fed enjoying most of the spotlight last and this week, the euro has silently profited from attention moving away from weak European macro data. However, after having risen by 3.9% in just eight trading days, reaching the highest level since February 2022 at $1.1270 on Tuesday, EUR/USD quickly fell back below the $1.12 mark in yesterday’s trading.
While global sentiment and optimism surrounding US disinflation continued to favor risk assets like equities, both the euro and pound suffered from a weaker UK inflation print and investors taking profit from the recent rally. The final revision of Eurozone core inflation by 10 basis points to 5.5% has not been able to support the common currency, as expectations have already built around an ECB hike in July. And with most Governing Council members pushing back against pre-committing to a September hike, only data after the July meeting will substantially matter for rates expectations.
Currency pairs are strongly influenced by relative moves in interest rates. However, swap differentials and Fed vs. ECB pricing can, in our opinion, not fully explain the move higher above $1.12 in EUR/USD. Overall risk sentiment, equity differentials and positioning are currently doing the heavy lifting in explaining FX markets, which makes forecasting the market very difficult at the moment. The next risk event in Europe will be the release of Consumer Confidence later today.
Pound suffered one of its worst days in 2023
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: July 17-21
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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.
