Important calendar events
The dollar plummeted on Monday and the dollar index dipped below 104.2. US treasury yields also retreated putting pressure on the dollar, with the US 10-year bond yielding approximately 4.40%.
Manufacturing PMI data on Monday showed that the US Manufacturing sector continues to contract. The ISM Manufacturing PMI index remained below the threshold of 50 required to denote industry expansion for the second consecutive month in May. The index dropped to 48.7 in May from 49.2 in April against expectations of a 49.8 reading, indicating the sector is contracting faster.
One of the key factors that are driving the dollar right now is the US rate outlook. As expected, the US Federal Reserve kept interest rates unchanged at its latest policy meeting, within a target range of 5.25% to 5.50%. The US Federal Reserve has held interest rates steady since last July. Fed chair Jerome Powell stated that, while future rate hikes are unlikely, US inflation has not cooled sufficiently to allow the central bank to proceed with rate cuts.
Odds of a rate cut in September have dropped close to 50% as Fed policymakers have expressed disappointment in the progress of disinflation in the US. Fed officials have stressed that more evidence of cooling inflation is required before a policy change can be considered.
Currently, only 25-50 basis points of rate cuts are priced in within the year. Market expectations of rate cuts are becoming more moderate as policymakers have stated that they intend to start reducing interest rates slowly. The uncertainty around Fed rate expectations is likely to continue in the coming months causing volatility in Forex markets.
US CPI data for April showed that disinflation in the US is finally progressing. Monthly inflation rose by just 0.3% in April, falling below expectation of a 0.4% raise. More importantly, headline inflation in April eased to 3.4% on an annual basis from 3.5% in March, which was in line with expectations. Core inflation, which excludes food and energy, came in at 3.6%, its lowest reading in three years.
Core PCE Price index data released last week showed that inflationary pressures in the US are easing, putting pressure on the dollar. This is the Federal Reserve’s preferred inflation gauge and may affect the Fed’s rate outlook. Core PCE Price index rose by just 0.2% in April from 0.3% in March against expectations of 0.3% growth. Core PCE came at 2.8% on an annual basis, which was in line with expectations, marginally exceeding March’s print of 2.7%.
The US economy expanded by just 1.3% in the first quarter of the year falling considerably below the 3.4% expansion registered in Q4 of 2023. The US economy is expanding at an increasingly slower pace putting pressure on the dollar, as GDP data have shown expansion by 4.9% in the third quarter of 2023. In addition, the Preliminary GDP Price Index rose by just 3.0% in Q1, which represents a downward revision of 0.1% from the previous estimate.
This week the US labour report is in focus on Friday. The most highly anticipated fundamentals this week are the US Non-Farm Payrolls (NFPs) on Friday. Before the release of the labor report, however, we have other important data coming up, especially in the employment sector. JOLTS Job Openings are scheduled to be released on Tuesday, ADP Non-Farm Employment Change data are due on Wednesday and Unemployment Claims on Thursday.
The EUR/USD rate was catapulted above the 1.090 level on Monday as the dollar plummeted. If the EUR/USD pair declines, it may find support at 1.078, while resistance may be encountered near 1.098.
Final Manufacturing PMI data released on Monday for the Euro Area showed that the EU manufacturing sector continues to contract. EU Manufacturing PMI came in at 47.3 in May, which was in line with expectations, but exceeded April’s 45.6 print. The EU manufacturing sector continues to contract, as evidenced by a print below the threshold of 50 that denotes industry expansion, but the rate of contraction has been reduced considerably.
This coming week, the market focus will be on the ECB interest rate decision on the 6th. The ECB kept interest rates unchanged at 4.50% at its latest monetary policy meeting but hinted at a dovish shift in the future. ECB President Christine Lagarde has expressed confidence that Euro area inflation is under control and has pointed to a rate cut in June.
Markets are expecting the ECB to start cutting interest rates at Thursday’s meeting, after keeping rates at record highs since September. This will increase the policy gap between the ECB and the Fed, as the Fed is not expected to start cutting interest rates before the final quarter of the year.
The Euro is under pressure by expectations that the ECB will start lowering interest rates this week. The Fed is not likely to start cutting interest rates before September, putting the Euro at a disadvantage against the dollar. In addition, markets are currently pricing in 35 basis points of Fed rate cuts within 2024, compared to 65 bps of ECB rate cuts.
An ECB rate cut this week is considered highly likely and is already priced in by markets, but the big question right now is how the central bank will proceed after the first cut. Several ECB members have spoken in favor of continuing rate cuts, possibly with consecutive cuts at the next meeting in July. Sticky inflation, however, may slow down the pace of future rate cuts. Traders will focus on ECB President Christine Lagarde’s statement after the meeting for guidance into the ECB’s policy outlook.
On the data front, Eurozone inflation data came out hotter than anticipated last week, propping up the Euro. German CPI data released on Wednesday showed that German inflation rose to 2.4% year-on-year in May from 2.2% in April. Monthly inflation in Germany, however, rose by only 0.1% in May against expectations of 0.2% and a 0.5% print in April.
More importantly, flash CPI released last week for the EU showed that headline inflation in the Euro Area accelerated to 2.6% year-on-year in May up from 2.4% in April and exceeding the forecast of 2.5%. Core CPI, which excludes food and energy, rose to 2.9% on an annual basis in May from 2.7% in April against expectations of a 2.7% print. Inflationary pressures in the Eurozone are not easing as fast as anticipated, which might hold up the ECB’s plans to lower interest rates.
The Eurozone economy expanded by 0.3% in the first quarter of the year, which was in line with preliminary estimates. GDP data for Q4 of 2023 showed that the Euro area economy was stagnant with a GDP print of zero. The EU economy contracted by 0.1% in the third quarter of 2023 and barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1.
The GBP/USD rate registered its highest value since March on Monday. The currency rate skyrocketed above 1.281 as the dollar dipped. If the GBP/USD rate goes up, it may encounter resistance near 1.289, while support may be found near 1.264.
The British Manufacturing outlook is improving, according to PMI data released on Monday, boosting the Sterling. The UK Manufacturing sector was at its fastest pace in over two years in May with Manufacturing PMI rising to 51.2 in May from 49.1 in April. The British manufacturing sector has moved out from contractionary territory and has started to expand, as indicated by a print above the threshold value of 50.
The BOE kept interest rates steady at its latest monetary policy meeting. The BOE maintained its official rate at 5.25% but showed signs of preparing for a dovish pivot.
Inflationary pressures in the UK are not easing as fast as anticipated reducing expectations of BOE rate cuts. British headline inflation eased to 2.3% in April on an annual basis from 3.2% in March from 3.4%, exceeding expectations, however, of a more drastic drop to 2.1%. Annual Core CPI, which excludes food and energy, fell to 3.9% in April from 4.2% in March, again surpassing expectations of a 3.6% print.
The BOE had updated its inflation outlook earlier this year, predicting that inflation would drop to the BOE’s 2% target in the second quarter of the year. The BOE’s forecasts were not confirmed, however, which may force BOE policymakers to keep interest rates at restrictive levels for longer.
Currently market odds of a BOE rate cut in June are very low and even a rate cut in August is considered unlikely. Markets are pricing in a rate cut in September with a high probability, while a rate cut by November is fully priced in. Rate cut expectations shifted from two rate cuts and a total of 50 basis points of rate cuts in 2024 to a single rate cut and only a 25 bp reduction in rates within the year.
The British economy slipped into recession last year, contracting by 0.3% in the final quarter of 2023. Monthly GDP data for February released last week, however, revealed that the British economy has narrowly avoided slipping into recession and has expanded by 0.1%. More importantly, January’s GDP was revised upwards to show an expansion of 0.3%. The British economy is fragile and may force the BOE to pivot to a more dovish policy.
The Yen benefitted from the dollar’s decline on Monday and USD/JPY dropped to the 156.0 level. If the USD/JPY pair declines, it may find support near 153.5. If the pair climbs, it may find resistance near 157.7.
Japan’s manufacturing sector showed marked improvement in May according to PMI data released on Monday. Final Manufacturing PMI data showed that the Japanese manufacturing sector moved out of contractionary territory in May and started to expand, with a print of 50.4 up from 49.6 in April.
The BOJ kept all policy settings unchanged at its latest policy meeting, despite the Yen’s recent weakness. The BOJ had pivoted to a more hawkish policy at its previous meeting in March, ending its negative interest rate policy and raising the benchmark interest rate into the 0% - 0.1% range. The Yen continues to weaken as there is still a significant disparity between interest rates offered by the BOJ and those from other major central banks.
The Yen’s weakness is causing concern to Japanese officials who have been warning traders against speculative short selling of the Yen. Yen intervention concerns remain high, as Japanese authorities have been warning repeatedly that an intervention to support the currency might be imminent. Japanese authorities have intervened to support the currency in the past and may do so again if the Yen continues to decline. Concerns about an imminent intervention have been keeping Yen short sellers in check, providing some support for the currency.
On the data front, inflation in Japan remains weak. Tokyo Core CPI rose to 1.9% in May from 1.6% in April, which was in line with expectations, but remained below the BOJ’s 2% target. Headline inflation dropped to 2.2% year-on-year in April from 2.6% in March, which was in line with expectations. BOJ Core CPI dropped to 1.8% on an annual basis in April, falling short of expectations of 2.2% and dropping from 2.2% in March according to data released on Tuesday. Low inflation in Japan is preventing the BOJ from raising interest rates putting pressure on the Yen.
Preliminary GDP data for Q1 of 2024 for Japan showed that the country has slipped into recession. Japan’s economy shrank by 0.5% in the first quarter of the year against expectations of a 0.3% drop. Japan’s economy registered a small expansion by 0.1% in the final quarter of 2023, showing that the country’s economy is shrinking. Recession concerns limit the odds of a BOJ hawkish pivot in the coming months.
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Written by:
Myrsini Giannouli
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