Chief Macro Strategist
Summary: The ECB meeting saw the central bank’s rate hiking intentions marked sharply higher, and yet the euro fell sharply by the end of the day, likely as the ECB has no real plan for quantitative tightening, and more immediately as EU peripheral yield spreads blew sharply wider yesterday. Today, the focus pivots to the US May CPI print, and particularly whether core CPI continues to roll over or proves stubbornly high. Fed tightening expectations for the remainder of this year are at the highs of the cycle ahead of the data release.
FX Trading focus: ECB jolts yields higher, but Euro drops. Focus pivots to US CPI today
To answer the question from yesterday’s FX Update, the ECB did indeed clear the bar of expectations for rate tightening at yesterday’s meeting. While there was the mildly dovish fact that the statement explicitly guided for a 25-basis point lift-off in July, it left the potential for a 50-bp move open for September, cancelling out the July guidance. More importantly, the new staff projections lifted the 2023 CPI forecast to 3.5% and the 2024 forecast to 2.1%, so above the target rate. As well, the “ex Food and Energy” forecast for 2024 was raised to 2.3% from 1.9%, an even more marked signal for the ECB taking the rising inflation threat more seriously. In reaction, the German 2-year Schatz yield rose as much as 13 basis points to a new cycle high above 80 basis points. Alas, the euro weakened, perhaps because we still have no general sense that the ECB can ever mobilize a proper real quantitative tightening and more immediate as peripheral sovereign yield spreads blew sharply wider despite promises to shift PEPP reinvestments to avoid “fragmentation”. The Germany-Italy 10-year yield spread trades 223 basis points as of this writing, a rise of over 20 basis points from the level before the ECB meeting. EURCHF was knocked back lower after teasing the 1.0500 resistance and a more hawkish SNB next week could cement a fall back into the lower range for that pair.
Chart: EURUSD
EURUSD rolled over badly in the wake of the ECB meeting, as did EURCHF and EURJPY. The correlation with risk sentiment is notable, and a higher than expected US CPI print today that both raises Fed hike expectations further and sees equities threatening to challenge the market lows could see this pair pushing down to the cycle lows again if the 1.0500 area support can’t halt the slide.
The US May CPI data point up later today is critical here as it appears the market is getting nervous that the prior hopes for fading core inflation may be fading. The nominal expectations for today’s core US CPI print (ex food and energy) is +0.5% MoM with hopes that the YoY figure is set to drop to 5.9% vs. 6.2% in April and the cycle high of 6.5% in March. A cluster of strong CPI readings in April through June of last year are driving hopes that we are on the path lower core inflation prints, but a hot number today will spook this market and could drive another surge in the US dollar. A big pick-up in the US weekly jobless claims number to 229k raises the risk that the US labor market is rolling over (highest weekly print since January) and we are entering a stagflationary environment. Worth noting technically that AUDUSD breaking local support yesterday near 0.7150 and USDCAD reversing harder after the release of the Bank of Canada Financial System Review yesterday saw yields nudging lower. Comments on housing were prominent, as the review noted that many Canadians stretched to buy a home during the pandemic and sees heavily leveraged households as a key risk for the economy.
Next week we have an FOMC meeting on tap and leading indicators on the US housing market, like the NAHB survey for June. We also hear from the SNB on Thursday, which at minimum should be signaling a September rate hike.
This morning, Czechia reported a staggering 16.0% CPI rate for May, a new cycle high above the April 14.2% level. The Czech central bank remains one of the more credible in setting its rate policy and with a tremendous pot of reserves if the need arises for their mobilization. I would normally like the EURCZK carry trade with the Czech central bank backstopping CZK longs, but Czech president Zeman yesterday named three new central bankers to the central bank and refused to extend terms for two more hawkish central bank members. Last month, the president appointed a vocal dove, Ales Michl, to the governorship of the central bank starting in July. Zeman believes that inflation is due to external shocks and that a steep tightening trajectory could drive inflation higher still. Sounds a bit too Erdogan-esque for comfort. EURHUF is another CEE situation to watch as it pokes at record highs – negative real rates in Hungary are likely to get far worse.
The signals from Japan are worth watching more than ever next week, most obviously at the Friday Bank of Japan meeting, but we got signs already today that the discomfort level with the weak JPY is rising. A meeting of the BoJ, MoF and FSA today produced a statement saying that they would act appropriately if needed – likely meaning that anything resembling the price action we saw this week will elicit an escalating response if the market is not immediately impressed with first verbal intervention, then currency intervention, etc. Only a strong backing down of global yields or a Bank of Japan will do the trick in firmly resetting the JPY higher – volatility will prove more two-way from here.
Table: FX Board of G10 and CNH trend evolution and strength.
The euro’s budding wings clipped yesterday in the wake of the ECB. Watching whether the US dollar fully recovers its wings in the wake of the US CPI today. As noted above, the ability of the JPY weakness to intensify may be difficult as the intervention threat rises. Elsewhere, watching whether the CAD speed-bump develops into something more significant.
Table: FX Board Trend Scoreboard for individual pairs.
Note AUDUSD tilting lower again today – a fall below 0.7000 sets the momentum more firmly negative there and is still some way off. USDCAD has been in for a shock after yesterday, but it takes more time to shift the trend positive, as well as a move back well above 1.2800. EURUSD, USDNOK and USDSEK round out the USD/G10 pairs pointing to a USD shift back higher here – key today whether US CPI release confirms the development.
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