Signs of the US economy losing steam are mounting as the incoming data surprised to the downside on all occasions this week. However, political turmoil in Europe, Trump rising in the polls and FX weakness in Asia have added to the dollar’s appeal.
The United Kingdom was the fastest growing G7 economy in the first quarter. The ONS upgraded its previous estimate for growth of 0.6% to 0.7% in the first quarter just before the general election on the 4th of July.
The rising rate differential between the US and China is putting upward pressure on USD/CNY as Chinese bond yields on the longer end continue to slide to two-decade lows. USD/JPY rose to the highest level since 1986 and breached the ¥161 mark.
Leading surveys for the Eurozone and Germany have come short of expectations this month, suggesting that the path towards recovery remains rocky. Sunday will kickstart the two-stage French election that will decide the next parliament.
The US dollar is eying its fourth weekly rise on the trot, as FX markets trade-off between politics and policy. The first US presidential debate saw odds of Trump winning soar as high as 65%.
Renewed risk aversion across financial markets limited the euro’s ability to claw back the recent politically induced losses. The Euro index is down 0.7% thus far in 2024.
The upcoming week will be an important one for markets. Besides UK and French politics, European inflation data, US PMIs and the labour market report and Chinese and Japanese leading surveys will be watched as well.
Global Macro
Politics driving markets
Slowing economy. Signs of the US economy losing steam are mounting as the incoming macro data surprised to the downside on all occasions this week. Weaker consumer confidence and regional Fed PMI surveys, rising initial jobless claims and pending home sales falling to a record low have pushed the US surprise index to its lowest level since mid-2022.
Politics aiding the dollar. The US Dollar Index continued to slowly trend higher despite both nominal and real yields having fallen in June and macro data disappointing. Political turmoil in Europe and FX weakness in Asia have added to the dollar’s appeal with both French and UK general elections coming up over the next few days. For the currency to start giving up some of its year-to-date gains, we would have to see a continuation of the global disinflation trend and for politics to move out of the spotlight.
Biden fallout. Investors kept a close eye on the first US presidential debate between Democratic President Joe Biden and his Republican rival Donald Trump in early Asian hours on Friday, ahead of November’s US election. Market odds favoring Trump rose above 65% in the wake of the debate, which could translate to upside risks in inflation. That would mean the Federal Reserve keeps rates higher for longer, US Treasury yields stay elevated, and the US dollar remains resilient.
FX weakness in Asia. The rising rate differential between the US and China is putting upward pressure on USD/CNY as Chinese bond yields on the longer end continue to slide to two-decade lows. Policy makers are trying to walk a fine line between stimulating the economy, while keeping an eye on the depreciation of the yuan and excessive rally in its domestic bond market. USD/JPY meanwhile rose to the highest level since 1986 and breached the ¥161 mark.
Regional outlook: United Kingdom
Strong growth going into the election not enough
Growth revised up for Q1. The United Kingdom was the fastest growing G7 economy in the first quarter. In a boost for UK Prime Minister Rishi Sunak’s argument that the nation has turned the corner after a recession last year, the ONS upgraded its previous estimate for growth of 0.6% to 0.7% in the first quarter. Services drove the increase, jumping 0.8%, revised up from 0.7%, and capping three consecutive quarters of decline. Consumer spending and trade also came in stronger.
Wage growth still too high for the BoE. Advertised pay on the Indeed jobs search site rose by 6.5% in the year to May, and although part of that was due to a 9.8% jump in the minimum wage in April, it also reflects worker shortages since the pandemic. The figures provide a more up-to-date snapshot of trends in the labour market, which the BoE is watching carefully for signs of upward pressure on prices. Policy makers have said wage growth remains too fast to be compatible with the UK’s 2% inflation target, an issue that may force borrowing costs to remain at a 16-year high for a little longer.
Heading into the UK election. Investors are gearing up for the upcoming UK general election next week as the Conservatives are expected to lose their majority to the Labour party. During the last UK election in 2019, the Conservatives won an 80-seat majority whilst Labour suffered its worst election defeat since 1935. Political volatility was rife amid Brexit-related uncertainties, and the British pound was vulnerable to sharp and significant price swings. Times have changed since then. Brexit is no longer a political hot topic spawning added uncertainty. The opposition Labour Party is more than 20 points ahead of the ruling Tory Party in the polls – a gap that will probably narrow but will be extremely challenging to overturn. Markets usually prefer continuity over change, but Labour’s shift to a more pro-business, centre-ground position is seen as favourable for UK assets. Plus, potentially closer ties with the European Union could help narrow the pound’s so-called Brexit risk premium.
Regional outlook: Eurozone
Consumer optimism diminishes
German morale weakens in June. A number of leading surveys have come short of expectations this month, suggesting that the path towards recovery remains rocky. The GfK Consumer Climate Indicator fell to -21.8 heading into July, down from the previous reading of -21.0, a marked decline in the consumer morale for the first time in five months. On the business side the trends are reciprocated, as the June Ifo German business sentiment dropped unexpectedly. The weaker sentiment adds some downside risk; however, we continue to expect growth to pick up slightly in the coming quarters.
Markets make peace with National Rally victory. A poll of polls by Bloomberg sees a widening of Marine Le Pen National Rally’s lead to over 35% with the leftist New Popular Front alliance stable at 28%. Markets appear to be getting comfortable with the National Rally victory, especially after Le Pen’s party attempted to ease market concerns on the fiscal side. Nonetheless, the OAT-Bund 10-year spread continues to hover around the above 80bps.
Disinflation trend resumes. The preliminary annual inflation rate in France eased to 2.1% in June 2024, the lowest level since August 2021, after an uptick in May to 2.3%. Similar trend was evident across Spain and Italy, thus increasing the risk of a downside surprise to the headline inflation rate next week. This could see market participants increase their near-term ECB rate cut bets, which would be euro negative.
ECB opens a door to additional easing. The ECB’s Rehn, a generally neutral Governing Council member, has endorsed market easing bets saying that that market pricing for two more rate cuts in 2024 looked “reasonable”. The ECB’s rate trajectory remains data-dependent, but the comment provides a signal of tolerance towards inflation bumps.
Week ahead
A big week beginning on Sunday
The first half of the year is likely to end with equities in the United States and Japan at all-time highs and political risks coming to the forefront again. Investors will pay close attention to the elections in France on Sunday and the United Kingdom on Thursday. Short-term implied FX volatilities have risen recently to incorporate the uncertainty surrounding the upcoming political events.
Inflation in Europe. However, the macro data can’t be dismissed either. European inflation data could show renewed slowing of price growth and might strengthen the case for the ECB to cut interest rates two times this year. Inflation is expected to have slowed from 2.6% to 2.5% with recent survey data suggesting the possibility of a slight downside miss to the consensus.
Jobs in the US. In the United States, both the ISM PMIs for the manufacturing and service sector (June) will be watched for signs of the economy slowing. The main event will come in the form of the labour market report on Friday as economists expect a stepdown in hiring from 272k to 185k. The Fed minutes from the last FOMC meeting might shed some light on policy makers’ rational for revising down the expected policy path for this year from three to one cut.
Surveys in Asia. Soft data like the Tankan and Caixin surveys could grab headlines in Japan and China as the former is expected to show strong growth, supporting a potential rate hike from the Bank of Japan. With USD/JPY above the ¥161 level, intervention risks remain elevated as the Ministry of Finance replaced its top currency diplomat this week.
FX Views
Asian currencies hobbled by strong dollar
USD Strong week, month and quarter. The US dollar is eying its fourth weekly rise on the trot, as FX markets trade-off between politics and policy. The first US presidential debate saw odds of Trump winning soar as high as 65% and this could translate to upside risks in inflation that might mean the Fed keeps rates higher for longer. Although the US dollar index has strengthened for two quarters running, amounting to an over 4% ascent, it is still around 7% from its 2022 peaks. But we question how much scope there really is to narrow that gap. The dollar has continued to slowly trend higher despite both nominal and real yields falling in June. Plus, signs of the US economy losing steam are mounting as incoming macro data has surprised to the downside on all occasions this week. The macro and yields based support the US currency has enjoyed for the most part of this year is starting to wane. Hence, its safe haven allure is what’s overshadowing currently amidst the political turmoil in Europe and FX weakness in Asia. For the USD to start giving up some of its 2024 gains, we would have to see a continuation of the global disinflation trend and for politics to move out of the spotlight.
EUR Euro remains under pressure. Renewed risk aversion across financial markets limited the euro’s ability to claw back the recent politically induced losses. The Euro index is down 0.7% thus far in 2024 yet remains largely propped up by gains of almost 10% versus the yen. EUR/USD closed out Q2 with a 0.5% loss, further increasing the YTD loss to 3.2%. The upcoming second round of French parliamentary voting and the preliminary Eurozone inflation report will be the key domestic events in determining the euro’s direction. Unless we see a marked deterioration in the US economic data, the near-term risks are skewed against the common currency. The short-term sentiment is euro bearish against all G10 peers apart from NOK and SEK and the demand for EUR/USD tail risk is at 15-month high as investors rush to protect against the potential adverse euro moves. From a technical standpoint, EUR/USD remains supported by 100-week SMA at $1.0665, but if it were to breach past that level the pair could test the 2024 lows around $1.06.
GBP Tough month in run up to UK vote. The British pound has appreciated against less than 30% of a basket of 50 currencies worldwide in June, its worst monthly performance since September 2023. That said, it remains the best performing G10 currency after the USD so far in 2024. The second quarter has seen GBP/USD fall to a low of $1.23, finding support at its 100-week moving average before rallying back towards its 200-week moving average which has traded around the $1.2850-$1.29 area for the last twelve months. Sterling is lacking directional impetus ahead of the upcoming UK general election. In this low volatility environment, the pound remains an appealing currency given its high yield advantage, particularly against the likes of the euro. Despite real rate differentials suggesting the pound is overvalued, GBP/EUR has held above €1.18 for the longest stint since 2022. Ongoing European political risk could see the pair clip fresh 2-year highs soon. As for GBP/USD, from a wider lens, it is flirting at the top end of a long-term descending channel that’s been in place since 2014 and we ponder whether a Labour Party majority win could help send the pair back to $1.30, albeit gradually. Options traders aren’t betting on fireworks going off at this election though, with 1-week implied volatility for GBP/USD residing well below its 2024 average.
CHF Buoyant until political risk lifts. As we expected, the rate cut by the Swiss National Bank (SNB) last week failed to sustainably reverse the franc’s ascent in June. The SNB is not the only central bank easing, and the franc’s haven allure to investors seeking European exposure will likely persist until French political uncertainty lifts. This has subsequently led EUR/CHF to its biggest monthly decline since December 2023 and its fourth quarterly decline in five. Much of EUR/CHF’s trajectory earlier in the year was guided by pricing on the ECB’s rate trajectory relative to the SNB, with the pair within striking distance of parity in May. But a spike in safe haven demand helped the pair fall as much as 3.4% in June, back into the central area of its 6-year downtrend channel and testing the Fr0.95 handle. Further franc gains cannot be ruled out in the short term as highlighted by one-week EUR/CHF risk reversals trading at almost 150 basis points, puts over calls, the most bearish sentiment for the euro versus the franc since March 2022.
CNY Anticipation builds for China’s economic policy direction. The upcoming Politburo meeting may reveal the timing of China’s third Plenary Session, a key event for economic policy-making. Expectations are centered on technology self-sufficiency initiatives, with less emphasis on consumer or property market stimulus. Discussions around tax reform are possible, though concerns persist about potential increased tax burdens, especially following recent fiscal revenue challenges. Traders will be closely watching the release of manufacturing and non-manufacturing PMI data for insights into economic performance. The USDCNH exchange rate surpassed the 7.30 threshold midweek, reaching levels not seen since late last year. Concurrently, the yuan’s daily reference rate has been setting new annual highs throughout last week. In political news, sources (Bloomberg) indicate that China’s upcoming third plenum is scheduled for mid-July, spanning from the 15th to the 18th of the month.
JPY Yen at weakest since 1986. USD/JPY broke above ¥161, and hit its highest level since 1986, raising intervention alarm bells. The last time that level was briefly breached on April 29 the Bank of Japan (BoJ) likely intervened and USD/JPY finished the day 1.3% lower at ¥156.35. However, because the move has been more controlled and overall FX volatility subdued, the risk of intervention is lower, and the threshold remains uncertain. Moreover, while verbal intervention has done little to strengthen the currency, even if the BoJ were to sell dollars, any pullback in the currency pair might be much shallower than previous ones as evidenced by relative calmness in FX options markets which show risk reversals only modestly in favour of bearish USD/JPY moves over the next week. Deeply negative real yields, a sluggish economy and a massive debt pile continue to pin the yen to the bottom of the FX macro fundamental scorecard. Upcoming soft data like the Tankan survey could grab headlines in Japan as its expected to show strong growth, supporting a potential rate hike from the BoJ, which should support the yen.
CAD Bearish bias intact. Hotter-than-expected May inflation challenged the market bets of a back-to-back Bank of Canada (BoC) rate cut, strengthening the argument for a more conservative approach. Such a move prompted a sharp upward shift across the Canadian bond yield curve, supporting the Loonie. The currency rallied against most G10 peers, with the largest advance registered against NOK, SEK and NZD. Despite that, USD/CAD remained virtually unchanged on a weekly basis as traders look to US-centric developments for direction. In fact, we have seen relatively subdued realised volatility across the spot market for the said pair, with realised vols plunging to fresh 4-year lows when measured on a 1-week basis. Mid-week USD/CAD risk reversals briefly eased to least CAD bearish in 3-months, but we think there is scope for further CAD weakness. Although the latest inflation print pushed back the timing of subsequent BoC cuts, the diffusion of inflation supports the argument for additional easing further down the road. We maintain that the magnitude of the policy rate divergence between the BoC and the Fed remains net negative on CAD. With the current market positioning the most CAD bearish on record, such an overstretched positioning limits the US dollar’s ability for substantial further gains, signaling that we are at or near a USD/CAD ceiling. Technical analysis concludes C$1.36-C$1.38 is the new range for the next couple of months, with a tendency to drift higher.
AUD Resilient Aussie sentiment amidst economic headwinds. Recent consumer sentiment data in Australia shows a modest uptick, suggesting household optimism despite ongoing cost-of-living pressures. The latest figures indicate robust spending intentions, with upcoming tax relief likely to boost consumption further. This aligns with the Reserve Bank of Australia’s cautious stance and could support potential monetary tightening if inflation surpasses expectations. On the technical front, AUD/USD displays an ambiguous price pattern. While the pair maintains support above a cluster of moving averages between 0.6590-0.66181, it has struggled to make significant upward progress. Market participants should monitor upcoming economic indicators, including construction and retail data.
