USD: US national holiday today

Equity markets have started the week mostly on the back foot while US markets are closed for a national holiday today. It appears that investors still have to fully digest the 75bp rate hike by the Fed last week and above all, the re-pricing higher in US rate expectations. On Wednesday, the FOMC clearly left the door open for another 75bp move in July, but now this prospect is becoming the base case for market participants, with the OIS curve pricing in 70 out of 75bp for July.

Over the weekend, FOMC member Christopher Waller explicitly backed a 75bp hike in July, mentioning that inflation needs to be taken down regardless of what is causing it. Waller is a known hawk, and this may not necessarily be the prevailing rationale among the majority of members, but signs that the Fed is indeed focused on fighting inflation over a potential economic slowdown are clear, and our base-case scenario is for another 75bp hike in July.

This week is quiet data-wise in the US, with some focus on housing data. Indeed, sharply rising mortgage rates and falling consumer confidence point to further trouble for home sales data and we do expect some quite grim numbers this week – especially in existing home sales. This is not something to be underestimated given that residential construction accounts for 2% of GDP and housing transactions strongly correlate with areas of retail sales.

That said, we think that Fed speakers will have a much bigger impact on global market sentiment and the FX market this week, with the main event to watch being Fed Chair Jerome Powell's two-day testimony to Congress. There are other Fed speakers lined up: James Bullard speaks on inflation today, and we’ll hear from Tom Barkin, Loretta Mester, Charles  Evans, Patrick Harker, and Mary Daly in the coming days.

Unless we see some explicit pushback against a 75bp hike in July, markets may consolidate their pricing for a Fed rate around 3.50% at the end of this year, which should offer some underlying support to the dollar. Incidentally, global risk appetite may struggle to recover just yet, especially considering the recent developments in the gas market and lingering concerns about China’s economic outlook, all of which should continue to fuel demand for defensive dollar positions. A return above 105.00 in DXY in the short term is our base case.

EUR: Macron in trouble

A couple of months ago, markets welcomed the outcome of the French presidential elections that saw President Macron being re-elected for a second term. Some observers had noted than that Macron’s still weakened figure may have struggled to hold on to a parliamentary majority in the June elections. Current projections from yesterday’s vote show that a surge in far-right votes has indeed stripped Macron’s party of its parliamentary majority. In a way, this makes May’s presidential election’s success a half-win and raises reasonable concerns about how smoothly the pro-growth reform path in France will be over the coming years.

The news doesn’t seem to have bothered the euro, and being more of a longer-term risk to the eurozone outlook, it is not too surprising. EUR/USD has once again found some anchor around the 1.0500 level, something we expect to happen over the summer months despite volatility looking likely to remain elevated.

This week, markets will focus on activity surveys in the eurozone, as consensus expectations point to a modest drop in June’s PMIs and in the German Ifo, which are set to be released on Thursday and Friday, respectively. On Wednesday, consumer confidence data will also be watched closely.

On the central bank side, we’ll hear from a number of ECB speakers today, including President Christine Lagarde, Chief Economist Philip Lane, Mario Centeno, Ignazio Visco, and Madis Muller. The discussions may continue to centre around the freshly announced tool to keep sovereign spreads in check, which has so far had the desired effect. We discuss this – and the FX implications – in this article. More stability in the eurozone peripheral bond market and not-so-bad PMIs may put a temporary floor under the EUR around the 1.0400-1.0450 area despite the dollar staying largely bid. But downside risks to the 1.02-1.00 area over the summer months on the back of sustained dollar strength and a deteriorating eurozone outlook persist.

GBP: Any rate pushback from BoE members?

The are surely a number of factors pointing to GBP weakness at the moment (above all, the grim UK economic outlook), but supported Bank of England rate expectations have indeed provided a floor for now, and GBP/USD has been stabilising at the centre of the 1.20-1.25 area.

We continue to see some risks that we’ll see some dovish re-pricing of those rate expectations, but for now, that may only come from some explicit pushback by any of the BoE speakers scheduled this week (we’ll hear from Jonathan Haskel and Catherine Mann today). That’s because on the data side we could see yet another modest acceleration in headline inflation, while the core rate may stay above 6.0%. Later in the week, retail sales data will also be in focus.

We could see cable hold above 1.20 for now despite the dollar staying largely bid, and EUR/GBP staying around 0.8550-0.8600.

JPY: FX intervention risk remains elevated

USD/JPY is stabilising around 135.00 this morning and may see limited volatility today as the US markets are shut. However, last week’s Bank of Japan announcement firmly reiterated the message that tighter monetary policy is not on the cards despite currency weakness. While short-term concerns are focused on preventing markets from disrupting the key transmission tool of loose monetary policy (low interest rates) via bond-market intervention, the currency weakness discussion is surely not getting any quieter and a hawkish tone by Powell during his testimony this week may well generate fresh weakness in the yen.

We have long discussed how FX intervention is not a straightforward policy move for G7 countries, but it’s hard to argue that this remains the only option on the table for Japanese authorities unless Treasury yields start to drop. Risks for USD/JPY remain tilted to the 136-138 area (and potentially even beyond) over the coming days, in our view.