The dollar is enjoying broad support. Bearish flattening of the US yield curve as the market moves to price Fed tightening and a tech-led sell-off in risk assets are the main culprits for the move. We see these two factors continuing to dominate in a week that sees the release of US CPI for May on Wednesday and a likely SpaceX IPO on Friday
USD: Fed Pricing and Risk-Off Mood to Keep the Dollar Bid
Friday saw one of the cleanest and broadest dollar advances in quite a while. The core driver of the move was the strong US jobs report, which has raised expectations that this year’s energy inflation shock is landing on fertile ground for second-round effects. The market is pricing close to 30bp of Federal Reserve tightening this year and 50bp of tightening by the second quarter of 2027.
At some point, that expected tightening will be too aggressive, but we cannot see that story being unwound this week. This is because it is another week for US price data, where the May headline CPI reading is expected to push through 4% year-on-year, and PPI final demand should remain near 6% YoY. We are now also in a Fed communication blackout period ahead of the 17 June FOMC meeting, meaning there is little to no scope for the Fed doves to push back against this pricing. In fact, we see the dollar staying bid into that FOMC meeting, given the market expects the central bank to remove its implicit easing bias.
At the same time, growing expectations of Fed tightening have caught an investor base overweight equities and overweight emerging markets. As we discussed in an article on Friday, it looks like investors might be selling off benchmark tech names to clear room in portfolios for Friday’s $75-85bn SpaceX IPO. There could also be an issue of indigestion here as well, given that Alphabet recently tapped the equity market for $85bn, and OpenAI and Anthropic also plan to IPO in the coming months. We see the Swedish krona and the Israeli shekel as the most tech-sensitive currencies in the G10 and EM spaces, respectively.
An unwind of risk assets and especially an unwind of emerging market positions is normally dollar-positive. This probably adds weight to US Treasuries as well, given that emerging market nations (and presumably Japan again sometime) will be liquidating Treasuries for FX intervention operations. One further source of dollar selling this week could come from Korea’s National Pension Service. In exceptional times, it can increase its benchmark 15% hedge ratio on foreign assets and has said that it is doing so today. As of April, it held over $400bn of foreign equities and bonds – a big chunk of which is presumably in the US.
The geopolitical backdrop is also shifting dollar-positive, with most surprised that Brent is not trading even higher now that Iran and Israel are directly exchanging fire.
DXY should stay bid and looks biased to test resistance in the 100.25/65 area. The dollar’s recent strength is a reminder that cyclical rather than structural factors continue to dominate.
EUR: ECB to Provide Some Rearguard Support for the Euro
EUR/USD was hit hard on Friday as the dollar surged across the board. This increases pressure on the European Central Bank to sound hawkish this Thursday when it is widely expected to raise its deposit rate 25bp to 2.25%. A hawkish-sounding ECB is our call, and one which will maintain the view that it will hike again in September when it has a new round of forecasts.
On the activity side, we have already seen a weak batch of German factory orders data for April today, and the risk is that eurozone manufacturing activity data now starts to deteriorate after hoarding/inventory building earlier this year around the uncertainty of the Gulf conflict.
With energy prices starting to turn bid again, expect EUR/USD to stay offered and 1.1500 to remain under pressure. At this stage, we probably think support in the 1.14/15 region has a chance of holding this summer, but it will remain pressured while the market explores the idea of a Fed tightening cycle.
GBP: BoE Will Try to Avoid Tightening
It looks as though the Bank of England will try to avoid tightening this year. The market expects relatively little of the Bank this summer, but does price 21bp of tightening at the September meeting. Friday’s release of inflation expectations data amongst the corporate community also gives the BoE some confidence that second-round inflation effects are less likely.
In theory, EUR/GBP should be trading higher if the BoE is dragging its feet on tightening at a time when the ECB is about to hike and the data is prompting a rethink on the Fed’s position. Equally, sterling is generally seen as a pro-risk currency with a large financial sector, meaning that it generally underperforms in a risk-off environment.
Given what should be a hawkish ECB meeting this week and a vulnerable equity environment ahead of large forthcoming supply, we favour EUR/GBP making a move back to 0.8680, while GBP/USD can test 1.3300 and has outside risk to 1.3200 this week.
