EUR takes a breather after yesterday’s sell-off

EUR/GBP: Key support broken at the 0.8500-level after pick-up in political risk

The euro has stabilized at weaker levels after yesterday’s sell-off in response to the pick-up in political risk in France. It follows the pick-up in political risk in South Africa, India and Mexico over the past week that also triggered domestic currency weakness. In our latest FX Focus report (click here) released yesterday, we outlined our thoughts in more detail on the latest political developments in France and their potential impact on euro performance going forward. The three main scenarios were outlined were: i) the RN party disappoints in the elections by failing to become the largest party in France. It would trigger a bigger initial relief rally for the EUR helping to lift EUR/USD back up towards the top of the current 1.0500-1.1000 trading range (probability @ 40%), ii)  the RN party becoming become the largest party in France but falling short of being able to form a majority in parliament even with support from other parties. Without a clear majority in parliament it becomes difficult to pass legislation. In this scenario, the EUR continues to trade at weaker levels closer to bottom of current 1.0500-1.1000 trading range. This is the policy grid-lock scenario of there being no clear path to stable government. (probability @ 55%), and iii)  the RN party winning big and being able to put together a coalition in parliament with support from other parties (Republican party & independents) to be able to govern. The outcome could initially trigger another leg lower for the EUR by increasing the risk of more disruptive policies being adopted in France. We would expect EUR/USD to fall into a lower trading range between 1.000-1.0500 (probability @ <5%). Ahead of the first round of the elections on 30^th June we expect the euro to continue to trade at weaker levels to reflect the higher level of political risk in France.               

The negative political developments in France have also resulted in the euro weakening against the pound. EUR/GBP has just broken below important technical support at the 0.8500-level which had been tested and held on a number of occasions over the past year. It opens the door for a further adjustment lower for EUR/GBP in the near-term. The release this morning of the latest UK labour market has though provided further mixed signals for the BoE who are weighing up when to begin cutting rates. In favour of cutting rates, the latest monthly figures continued to show signs that the labour market may be cooling with the number of vacancies still falling and unemployment rising, although earnings growth remains relatively strong. The unemployment rate has risen from a low of 3.8% at the end of last year to a fresh high of 4.4% in today’s report which is the highest rate since September 2021. For the whole economy, average weekly earnings growth held at 6.0% (3 month average YoY%) for the third consecutive month in April. Evidence of slowing wage growth was also only marginal for the private and services sector which came in at 5.8% and 6.1% respectively as they continue to run well above levels consistent with meeting the BoE 2.0% inflation target. The recent 10% increase in the National Living Wage has helped to support higher wage growth. The Pay As You Earn real time information provided more encouragement that wage growth is slowing. The PAYE median pay measure slowed to an annual rate of 5.2% in May which was the lowest level since October 2021 although the monthly figures can be more volatile than average weekly earnings. We are still sticking to our forecast for the BoE to start cutting rates in August but it is a close call and will require more convincing evidence that inflation and wage growth is continuing to slow in the UK in the coming months. We don’t expect today’s UK labour market report to alter the pound’s current bullish trend.                         

UK WAGE GROWTH IS MODERATING BUT REMAINS ELEVATED 

Source: Macrobond & MUFG GMR

EM FX: Unwind of EM FX carry trades ahead of FOMC policy update

Emerging market currencies have continued to weaken against the USD over the past week extending the sell-off since the middle of last month. The worst performing emerging market currencies over the past week have been the MXN (-3.7% vs. USD), PLN (-2.3%), BRL (-2.0%), HUF (-2.0%), CLP (-1.9%), and COP (-1.7%). In contrast, the Asian currencies of the THB (+0.1% vs. USD), TWD (0.0%) and CNY (-0.2%) have proven more stable.       

The USD has staged a sharp rebound over the past week driven primarily by the release of the robust NFP report for May. The report revealed that the US economy added 272k jobs in May which was a clear step back up after the slowdown to job gains of 165k in the prior month. For this year as a whole the US economy has added 248k jobs/month on average which is roughly in line with last year’s average of 251k/month. There is little evidence of a slowdown in employment growth so far this year. Alongside the upside surprise for average hourly earnings growth in May, the report will discourage the Fed from beginning to cut rates although at least the unemployment rate is still moving gradually higher indicating more slack in the labour market. The next important data release for the Fed and market participants will be the latest US CPI report for May. A second consecutive softer CPI report would provide reassurance that the pick-up in inflation in Q1 was only temporary. Whereas another upside surprise would encourage the Fed to deliver a more hawkish policy signal at the FOMC meeting on Wednesday. For the USD to strengthen much further, the Fed would have to signal that they are now only planning one rate cut this year or even go further  and cast doubt on the need for rate cuts at all this year.                       

The hawkish Fed repricing has contributed to less favourable conditions for EM FX carry trades. The higher yielding emerging currencies of the MXN, PLN, HUF, BRL, CLP, COP and ZAR have all been hit over the past week as popular long carry positions have been liquidated. The recent elections in Mexico and South Africa were important triggers for the carry trade unwind with the pickup in domestic political uncertainty weighing most heavily on MXN and then ZAR. The ANC party is continuing efforts to form a national unity government including with the market friendly Democratic Alliance. A development that could initially provide support for the ZAR if finalized in the week ahead especially if the left-wing parties choose not to join. Please see our latest EM EMEA Weekly for more details (click here).           

HIGH YIELDING EM FX CARRY TRADES HAVE TAKEN A HIT

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
US	11:00	NFIB Small Business Optimism	May	89.8	89.7	!
US	12:00	OPEC Monthly Report	--	--	--	!!
EC	12:00	ECB's Lane Speaks	--	--	--	!!
CA	13:30	Building Permits (MoM)	Apr	4.9%	-11.7%	!!
EC	17:45	ECB's Elderson Speaks	--	--	--	!!

 

Source: Bloomberg