USD rebounds alongside rising US yields triggering more risk-off trading

USD: Higher for longer Fed policy & Trump re-election risk in focus

The US dollar has been consolidating at weaker levels in recent weeks after the dollar index failed to break below support from the 200-day moving average at around 104.40. Similar to the dollar index, US yields bottomed on 16^th May and have regained upward momentum in recent days providing more support for the US dollar. It has resulted in the 10-year UST yield and USD/JPY pricing back above 4.60% and 157.00 respectively. The short and long end of the US yield curve have both risen sharply by around 30bps since the middle of this month driven mainly by the paring back of expectations for Fed rate cuts. The US rate market has become more confident that the Fed will only deliver a single rate cut later this year. There are currently only 13bps of Fed rate cuts priced by September and 32bps by December. It highlights that market participants are expecting the Fed to deliver a hawkish policy update at the next FOMC meeting on 12^th June when the updated economic projections are expected to an upward revision to the inflation forecast for this year (core PCE deflator was set at 2.6%) and a reduction to plans for three rate cuts for this year. At the current juncture, we still believe it is unlikely that the Fed will deliver a a much stronger signal next month that rates are now unlikely to be lowered his year. In light of current market pricing for one Fed rate cut it sets a high hurdle for the US dollar strengthen more significantly in the near-term. The release later today of the second estimate of US GDP growth for Q1 is expected to reveal that the US economy slowed more sharply at the start of this year with growth slowing to an annualized rate of closer to 1.0% after averaging robust growth of 4.2% in the 2H of last year. However, it is unlikely to materially ease Fed concerns over inflation risks. The Atlanta Fed’s GDP tracker for Q2 is currently estimating that growth is likely to pick back up in Q2 so it appears unlikely that weaker growth in Q1 is the start of a more sustained slowdown.         

One additional factor that could be providing additional upward momentum for the US dollar are political developments in the US. The probability of Donald Trump being re-elected as President in November has increased significantly this month as measured by PredictIt.com from a  low of 43% in April to the recent high of 53%. The current legal trial involving Donald Trump does not appear to be harming his popularity. In contrast, the probability of President Biden being re-elected has fallen sharply from a high of 55% in April to the current reading of 44%. Donald Trump now leads by the widest margin so far this year. If the trend continues heading into the 2H of this year it could encourage further US dollar strength. The US dollar could strength on the back of building expectations for greater trade disruption and looser fiscal policy under a Trump second term even though there have also been reports that he would prefer/seek a weaker US dollar to boost the external competitiveness of the US economy.        

RISK OF 2^ND TRUMP PRESIDENCY HAS INCREASED RECENTLY

Source: Bloomberg, Macrobond & MUFG GMR

EUR: Euro-zone CPI report is unlikely to alter ECB rate cut plans for June  

The broad-based US dollar rebound has resulted in EUR/USD falling back below the 1.0800-level overnight and back towards support from the 200-day moving average at around 1.0790. The euro failed to benefit yesterday from the release of stronger inflation data from the Germany for May. The latest CPI report revealed that the annual rate of harmonized inflation picked up to 2.8% in May from 2.3% in April. However, there was some reassurance that the core inflation rate remained stable at 3.0%. The pick-up in headline inflation was driven by the service sector where inflation rose to 3.9% in May from 3.4% in April. As expected it was mainly driven by positive base effects from the introduction of a Germany-wide subsidized transport ticket in May of last year. There was also a stronger rebound in the prices of package holidays which were up 5.6%M/M in May following a drop of -0.3%M/M in April. Overall, the developments have not significantly altered market expectations ahead of the release today of the latest euro-zone CPI report for May. The report is still expected to reveal that headline inflation increased modestly to 2.5% in May while core inflation remains stable at 2.7%.

The pick-up in headline inflation in the euro-zone in May is expected to prove temporary and does not alter expectations for inflation to slow back towards the ECB’s target this year. ECB officials have signalled clearly that they plan to begin cutting rates in June which is backed by even the more hawkish officials. A view that was summed up by Banque de France Governor Villeroy de Galhua who stated this week that “barring a surprise, the first rate cut in June is a done deal”. However, it is less clear what will happen after the first rate cut. More hawkish ECC officials including Executive board member Schnabel, Bundesbank President Nagel and Dutch central bank Governor Knot have already stated their opposition to a follow up rate cut as soon as in July. The release of stronger than expected negotiated wage growth from the euro-zone for Q1 which rose to 4.7%Y/Y up from 4.5%Y/Y in Q4 2023 has encouraged market participants to scale back expectations for further ECB rate cuts through the rest of this year although the Q1 figure was boosted by one-off payments in Germany. The euro-zone rate market is currently pricing around 58bps of ECB cuts by the end of this year. While we still expect the ECB to deliver three rate cuts by the end of this year, the recent paring back of ECB rate cut expectations alongside evidence of stronger cyclical momentum for the euro-zone economy are helping to provide more support the euro in the near-term. The euro now appears to be an important technical juncture against both the US dollar and pound. EUR/GBP is currently testing support at the 0.8500-level which has been tested and held for almost a year, and EUR/USD has fallen back to support from the 200-day moving average at around 1.0790. It has increased the risk that the euro could weaken further if those support levels are broken ahead of the ECB’s upcoming policy meeting on 6^th June.      

EUR HAS BEEN CORRECTING LOWER IN 2H OF MAY

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
SZ	08:00	GDP (QoQ)	Q1	0.3%	0.3%	!!
EC	10:00	Business Climate	May	--	-0.53	!
EC	10:00	Consumer Confidence	May	-14.3	-14.7	!
EC	11:00	Eurogroup Meetings	--	--	--	!!
US	13:30	GDP (QoQ)	Q1	1.6%	3.4%	!!!
US	13:30	Initial Jobless Claims	--	218K	215K	!!!
CA	13:30	Current Account	Q1	-5.5B	-1.6B	!!
US	17:05	FOMC Member Williams Speaks	--	--	--	!!
UK	19:50	BoE Gov Bailey Speaks	--	--	--	!!!
US	22:00	Fed Logan Speaks	--	--	--	!

 

Source: Bloomberg