Written by Convera’s Market Insights team
Dollar slides after cooling US inflation
Boris Kovacevic – Global Macro Strategist
The US dollar struggled for direction last week, dropping to a 2-week low on improved global risk appetite before surging to a 2-week high amid rising Treasury yields after a run of weak bond auctions. On Friday, though, yields and the dollar slipped after the Fed’s preferred inflation gauge eased last month, underpinning expectations the US central bank will cut rates later this year.
The so-called core personal consumption expenditures (PCE) price index, which strips out the volatile food and energy components, increased 0.2% from the prior month. That marked the smallest advance of the year and below market expectations of a 0.3% rise. This gave global risk sentiment a renewed boost with equities climbing across the board and the S&P500 ending May 5% higher. Overall, in May, the US dollar appreciated against less than 20% of its global peers, and the dollar index suffered its first monthly decline since December. The US dollar’s pullback has been accompanied by a drop in bullish wagers on the currency too. Speculators cut their long dollar bets for a fifth straight week., now holding roughly $14.6 billion in wagers betting that the dollar will rise, the lowest tally since the end of March.
Looking ahead, the US labour market report will take centre stage on Friday and the consensus is looking for a slight uptick in job creation at around 200k. This would be a solid print as the number would be neither too hot nor too cool for the Fed. Any deviation from this baseline could cause volatility across markets. Before the print on Friday, US job openings and the ISM manufacturing and services PMIs will be closely monitored too.
Pound regains top spot among G10
George Vessey – Lead FX Strategist
Sterling is holding up best among G10 currencies against the US dollar this year on growing expectations that the Bank of England (BoE) will lag many peers in cutting interest rates. The announcement of the snap UK general election has done little to shake this narrative reflecting anticipation that a potential change in government would revive political stability in the UK.
In fact, market participants appear to be cheerier about the prospect of the opposition Labour Party, far ahead in the polls, coming into power. London-listed stocks are hovering near record highs and the pound is holding firm against the dollar above $1.27, whilst GBP/EUR climbed close to €1.18 last week – its highest point since August 2022. In the short-term, the BoE’s cancellation of public engagements for its policymakers until after the UK general election could be seen as constructive for GBP too, as it lessens the already low risk of a BoE rate cut in June. With the ECB expected to commence its easing cycle this week, there is scope for GBP/EUR to run even higher but depends on the forward guidance that follows the expected rate cut.
The biggest downside tail risk to sterling over the next couple of months is a hung parliament result from the election, a scenario which saw GBP/USD shed over 2% in a week back in 2010 and 2017. For now, though, economic data, monetary policy and risk sentiment will continue to steer sterling.
Inflation uptick throws ECB cuts into question
Ruta Prieskienyte – FX Strategist
On Friday, the euro briefly rallied to a 2-week high of $1.088 as a batch of data pointed to an economic backdrop that could favour less restrictive monetary policy by the Fed, spurring US dollar weakness. Despite closing the week largely unchanged, EUR/USD managed to regain 1.3% throughout May and is currently trading -1.8% year-to-date, a marked improvement from mid-April, when the pair was 3.8% down on YTD terms. Meanwhile, German 2-year Bund yields briefly rose above 3.1%, the highest level since mid-November, but soon retreated as higher-than-expected inflation readings in the Eurozone made investors second guess how many cuts the ECB will deliver this year.
The annual inflation rate in the Eurozone rose for the first time in five months to 2.6% in May, up from 2.4% in each of the previous two months, and above forecasts of 2.5%, preliminary estimates showed. The uptick was driven by a rebound in energy and services prices. The core rate, which excludes volatile energy and food components, also increased to 2.9% from 2.7%, higher than expectations of 2.8%. Although the odds on the first rate cut from the ECB at the meeting later this week have remained virtually unchanged, officials are more likely to aggressively lean into a hawkish rhetoric in coming weeks, warning investors not to expect back-to-back cuts at subsequent meetings. As it stands, overnight swaps are pricing in a 57% probability of an additional rate cut in September.
Looking ahead, the key event this week will be the widely anticipated ECB policy rate decision and whether the central bank is expected to cut its key policy rates by 25bps from current record highs. Given the relative time divergence from the Fed’s policy, the event is likely to exert downward pressure on the euro. Reflecting these expectations, the 1-week implied option volatility for EUR/USD has spiked to a 2-week high, although it remains below its 6-month average. Market sentiment, as indicated by the 1-week EUR/USD risk reversal, is at its most bearish in nearly four weeks. However, the 10-delta flies for the same tenor, trading at 0.30 vol, imply that any significant movements in either direction are likely to encounter diminishing interest. This suggests that while volatility is expected, market participants may not sustain substantial directional bets.
Swiss franc rebounds over 1%
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 3-7
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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.
