As President Trump claims negotiations are in their ’final stages’, the FX market is trading a de-escalation with much more cautiousness than two weeks ago. The hawkish Fed backdrop is also making it harder to bet against the dollar. On the macro side, expect some focus on PMIs today
USD: More Resistant to De-Escalation Headlines
For the second time this May, markets are trying to trade a US-Iran peace deal after President Trump said negotiations were in their “final stages”. Conviction is lower this time. Rhetoric from both sides remains belligerent, and markets are more hesitant to chase optimistic headlines after earlier disappointments. Consistently, yesterday’s intraday fall in DXY was around half the move seen on 6 May.
The macro background is also making it harder to aggressively bet on the USD downside. The FOMC April minutes, published yesterday, were hawkish, with “many” members asking to signal that the next move could be a hike. That translates into a greater risk that Treasury yields will be stickier on the downside than they have been on the upside. Even after yesterday’s de-escalation headlines, 17bp of tightening remains priced into the Fed funds futures curve by December. That pricing should be unwound if a US-Iran deal is ultimately reached, but a quick return to pricing rate cuts looks far from guaranteed.
The dollar’s contained reaction to Trump’s comments leaves a relatively larger scope for further downside if a deal is indeed about to be agreed. But it also confirms thinner market patience, and a new period of a stall in negotiations could end up taking DXY above the 99.50 mark even without any new military re-escalation.
Today, the highlights in the US calendar are housing starts for April and May’s S&P Global PMIs. The latter are less impactful than ISM surveys but have the advantage of better comparability with European numbers, also published today.
EUR: ECB Won’t Promise a July Hike
A Reuters report citing ECB sources suggests the Bank will remain noncommittal about a July move after hiking in June. The intention is reportedly to cool expectations for back-to-back hikes, even as the inflation outlook shifts towards the adverse scenario. This is not particularly surprising, but it does put a cap on how far markets can take ECB pricing.
Attention today turns to the PMIs. The composite index is expected to be unchanged, with further weakness in manufacturing offset by a modest pickup in services. That said, survey volatility has increased, and the data comes with clear health warnings. The swings in sentiment around the Iran war mean response cutoff dates may distort the picture. In that sense, the European Commission’s new forecasts could provide a cleaner signal on the extent of growth deterioration.
Despite yesterday’s rebound, the macro backdrop for EUR/USD remains difficult. The pair likely requires a persistent stream of positive Middle East headlines to stay supported. In the absence of that, we would expect a move back below 1.1600 sooner rather than later.
AUD: Soft Jobs Report Endorses RBA Pause
A poor jobs report in Australia overnight hit the overbought AUD. Unemployment rose to 4.5% as employment dropped 18.6k in April, with a larger share of full-time job losses. PMIs were also pretty grim, with the composite gauge falling from 50.4 to 47.8, well into contraction levels.
All this endorses the cautious stance of the Reserve Bank of Australia after the May rate hike and has poured cold water on still-hawkish expectations for year-end. Our call remains for no more hikes in Australia, with markets still having one fully priced in by November.
But our more dovish view on the RBA does not translate into a less bullish view on AUD/USD. We see even greater downside risks for USD front-end yields, and AUD’s overall fundamentals and carry story remain highly attractive. Its high-beta nature makes corrections like the current one inevitable, but we retain a rather strong conviction on further AUD/USD gains into year-end, assuming a Middle East agreement is ultimately reached. Our summer target remains 0.73.
