Room for USD to continue correcting lower without fresh catalyst

EUR/USD: Euro is proving resilient to expectations for policy divergence

The dollar has continued to trade close to recent lows at the start of this week with the dollar index holding just above support from the 200-day moving average at around 104.40. The release last week of the weaker than expected US CPI and retail sales reports for April have encouraged a further correction lower for the US dollar in the near-term. There are no major US economic data releases in the week ahead to alter market expectations over the outlook for Fed policy so the main focus is likely to be the release of the minutes from the last FOMC meeting from 1^st May. Fed Governor Waller and Vice Chair Jefferson and New York Fed President Williams are also scheduled to speak ahead of the FOMC minutes released on Wednesday. The US rate market has moved back to more fully price in multiple rate cuts from the Fed by the end of this year following the release of the April US CPI report. There are currently around 45bps of Fed rate cuts priced in by December with the timing of the first rate cut expected in either September (21bps) or November (29bps). We continue to believe that the US rate market has gone too far at the start of this to remove Fed rate cut expectations leaving room for US rates to continue correcting lower after peaking out last month.           

At the same time, the release of the latest IMM positioning report revealed that long US dollar positions held by Leveraged Funds remained elevated in the week ending the 14^th May. US dollar longs were pared back modestly but remain close to the highest level since the start of 2022. Without a fresh catalyst to trigger renewed upward momentum in the week ahead, there is a risk that long US dollar positions will be cut back further extending the recent sell-off.

The recent run of disappointing US economic data releases has taken some of the shine off the US dollar even as monetary policies are set to diverge between the Fed and ECB in the coming months. While the Fed appears unlikely to begin cutting rates before the summer although a July cut can’t be completely ruled out at this stage, the ECB remains firmly on course to begin cutting rates in June unless there is a significant shock in the month ahead. The euro-zone rate curve is well priced for the ECB to begin cutting rates in June (24bps) and to deliver at least one or two more cuts by the end of this year (65bps). We expect the ECB to begin cutting rates in June and then to deliver a rate cut every quarter heading into next year. It appears unlikely that the ECB will deliver a faster pace of rate cuts especially if the Fed takes its time before cutting rates as well. Executive Board member Schnabel stated at the end of last week that a rate cut next month “may be appropriate”. However, she stressed that “based on current data, another back to back rate cut in July does not seem warranted” and emphasized that “we should follow a cautious approach”. She believes that it is “too early to commit to any particular rate path” given the “very high uncertainty” and with “inflation risks still tilted to the upside”. A more cautious path for ECB rate cuts would help the euro to remain more resilient against the US dollar alongside improving cyclical momentum for the euro-zone economy.         

LONG USD POSITIONING REMAINS ELEVATED

Source: Macrobond, Bloomberg & MUFG Research

Commodity FX: Assessing risks to the sustainability of recent strength

The commodity-related currencies of the NZD (+1.9% vs. USD), NOK (+1.5%) and AUD (+1.4%)  were amongst the best performing G10 currencies last week. For this month as a whole the NZD (+4.2% MTD vs. USD), NOK (+4.1%) and AUD (+3.4%) are top three performing G10 currencies. In contrast, the CAD (+1.2% MTD vs. USD) has been one of the worst performing G10 currencies with its performance remaining more tightly linked to the USD.

The high beta commodity-related G10 currencies of the AUD, NOK and NZD have benefitted from the improvement in external market conditions so far this month. MSCI’s global equity index has staged a strong rebound and hit fresh cyclical highs this week. The low point for global equity markets last month coincided with US yields and the USD putting in place a near-term peak on 16th April. The softer US CPI print for April has reinforced the recent improvement in global investor risk sentiment by further boosting optimism over a softer landing for the global economy. It keeps alive expectations for multiple Fed rate cuts later this year and there has already been evidence of stronger growth  at the start of this year in China and Europe. At the same time Bloomberg’s commodity price index has risen to year to date highs creating a more supportive external environment for G10 commodity currencies in the near-term.

Nevertheless, there remain concerns over the sustainability of stronger growth in China. The release of the latest monthly activity data for April was mixed. While industrial production surprised to the upside when it expanded by 6.7%Y/Y in April, it was offset by weaker than expected growth for retail sales (+2.3%Y/Y) and fixed asset investment (+4.2%Y/Y YTD Y/Y excluding rural). The report will play into building concerns that China could rely more on external demand to drive economic growth while domestic demand remains weak. However, domestic policymakers do appear to be taking a more active stance to provide more support for the housing market which remains an important headwind to growth for domestic demand. The latest package of measures announced (click here) included establishing a nationwide program to provide cheap loans to help state-owned companies purchase unsold homes. The PBOC expects the CNY300 billion of loans offered at a rate of 1.75% to result in an estimated CNY500 billion of credit overall. Lenders in the new program will be encouraged to extend financing to regional state-owned enterprises handpicked by local governments to support their purchase of unsold finished homes at reasonable prices. However, the size of the program has come in on the lower side of expectations putting a dampener on China growth optimism.

In response to the threat posed by China relying more heavily on ”unfairly underpriced exports” to drive economic growth, the Biden administration announced last week a fresh package of tariffs. National Economic Council Director Lael Brainard stated that “today, at a time when a strong US economic recovery is underway powered by domestic consumption and investment, there are signs that China is exporting its way to recovery…using the same playbook has before to power growth at the expense of others by investing in significant overcapacity and flooding global markets with artificially cheap exports”. The Biden tariffs which will take effect from 2024 and 2026 are more targeted covering USD18 billion of current exports from China. The new tariffs will apply to only around 4% of China’s exports and are intended to create a higher hurdle to prevent China from being able to build their presence in the US market for electric vehicles, batteries, solar cells, semiconductors and critical materials. While the tariff hikes are largely symbolic and will have limited economic impact on China in the near-term, we are wary of the risk that Europe will follow the US. In contrast to the US, Europe accounts for more than a third of China exports of green products and older generation semi-conductors.  Ahead of the US election, we expect investors to remain concerned over the risk of further global trade disruption acting as a dampener on G10 commodity currency performance later this year. Please see our latest FX Weekly for more details (click here).     

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
UK	10:00	BoE MPC Member Broadbent Speaks	--	--	--	!!
CH	11:00	FDI	--	--	-26.10%	!
US	12:30	FOMC Member Bostic Speaks	--	--	--	!!
US	14:00	Fed Waller Speaks	--	--	--	!!
US	15:30	Fed Governor Jefferson Speaks	--	--	--	!
US	19:00	FOMC Member Mester Speaks	--	--	--	!!

 

Source: Bloomberg