News & analysis


After a high octane start to the week, fuelled by the double whammy of EM election risk and weaker manufacturing PMIs, volatility in the broad dollar has begun to subside. Yesterday saw election risk remain localised, with the Mexican peso posting a significant rebound as the incumbent Finance Minister soothed investor concerns and the South African rand going the other way as the ANC floated the idea of a “National Unity” government that would see them form a coalition with parties such as the EFF. Meanwhile, the dollar found only marginal support from a significantly stronger ISM services PMI, which landed 2.8 points above expectations at 53.8. Even the Bank of Canada’s decision to cut rates and signal a willingness to ease further had little bearing on the broader G10 complex, as USDCAD had a brief foray into the 1.37s before retracing on the back of stronger equities.

We suspect markets will continue to trade in limbo again today, with the broad dollar likely pinned by the cross-asset crosscurrents until tomorrow’s North American jobs data. With the US data continuing to present mixed signals, especially around the durability of the consumer, the jobs report has taken on added importance. For the market’s base case of two Fed cuts to be endorsed, the labour market data will need to show a continued softening across both employment and wage measures. However, as we have recently noted, the pathway for this to be uniformly negative for the dollar is narrow, especially given the outsized moves in sentiment and yields this week. Any significant deviation from expectations on Friday should supply the dollar with fresh legs, an outcome that is seemingly keeping traders cautious as the dollar DXY index trades close to multi-month lows.


The ECB is set to follow in the footsteps of the SNB, Riksbank, and the Bank of Canada by cutting interest rates by 25 basis points later this afternoon, bringing the deposit rate to 3.75%. Given policymakers in Frankfurt have largely lined up behind this outcome, with Vice President de Guindos going as far as saying it is a “fait accompli”, anything but a cut will be a major shock. Barring that, the focus will instead be on the ECB’s forward guidance, which we suspect will cut in a hawkish direction. The recent stickiness in services inflation, coupled with signs of strength in the labour market and an acceleration in growth, should keep policymakers wary of dramatically loosening financial conditions. This should be reflected in the latest Eurosystem staff forecasts, which we expect to show a modicum of more inflation despite being conditioned on a higher market-implied policy path for the ECB. Set against this backdrop, President Lagarde’s cautious and data-dependent stance is likely to come across as hawkish too, keeping expectations of back-to-back cuts from the ECB contained as a tail risk. This should provide the euro with some support, although we doubt it is enough to push the single currency back into the 1.10s against the dollar seeing as such an outcome is already the market’s base case. Instead, we look towards Friday’s US payrolls data and the more fluid Fed expectations for any sizable move in EURUSD, with earlier non-recessionary rate cuts required for EURUSD to break above 1.10 this side of Q3.


While by and large it has been a quiet week so far for sterling traders, this morning’s Bank of England Decision Maker Panel data should offer something to chew over. Economists expect three-month inflation expectations to fall to 3.9% in May, down from 4.0% the month prior, while year-ahead expectations are also seen easing from 2.9% to 2.8%. That said, we suspect risks to today’s release are likely skewed to the downside given that DMP expectations tend to track realised price growth. This fell sharply to 2.3% in April, and should have slipped marginally once again last month. Admittedly, this is unlikely to change much for the BoE in the short run either way. The MPC is all but certain to keep rates on hold this month in light of the ongoing election campaign and the strong beat in services CPI. But a downside surprise would likely see rate cut expectations for the second half of the year advance at the margin, and this should see sterling trade with a modest softening bias today, if the DMP figures do surprise to the downside.


The BoC became the third G10 central bank to start cutting rates this cycle, delivering 25bps of easing yesterday. While the rate cut was broadly as expected and in line with our long standing call, the initial messaging contained in both the policy statement and Governor Macklem’s introductory remarks was more dovish than we had anticipated under our base case. Specifically, a note that “If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2% target continues to increase, it is reasonable to expect further cuts to our policy interest rate” appeared to open the door to back-to-back rate cuts. Given this, the initial market reaction saw USDCAD spike in response, aided too by better than expected ISM figures released just 15 minutes later. Despite the dovish signals in the policy statement, however, Governor Macklem’s press conference was much more in keeping with our pre-announcement expectations. As we saw it, the Governor was at pains not to commit to any particular easing path, or indeed, to say much of anything at all, preventing a blowout in easing expectations. As such, while swap markets currently price a 70% chance of a rate cut in July and 2.2 rate cuts projected for the second half of the year – a modest acceleration on pre-announcement pricing, USDCAD failed to stabilise above the 1.37 level overnight as equities supported a retracement in the loonie. For now we are retaining our base case, expecting one more rate cut from the BoC over the next two meetings, but given yesterday’s dovish signals, we think risks are skewed towards cuts at multiple successive meetings. The first test for this thesis comes tomorrow in the first of two labour market reports due before the BoC’s July meeting. Any signs that April’s strength in employment was misrepresentative, either through a downwards revision or a weak employment print in May, should embolden expectations of back-to-back cuts from the BoC over the coming months, leaving CAD vulnerable to a more dovish correction in Canadian rates.



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