News & Analysis


Yesterday, the loonie rose by just a little less than a percent against the dollar, one of the strongest performances in the G10 arena. Growing excitement about artificial intelligence helped shore up positive risk sentiment, but the risk-on rally truly picked up steam following the release of the ISM PMI report for the US. The prices paid index came in much lower than anticipated, suggesting that US inflation may have cooled in May. This development, alongside growing calls for the Fed to skip a hike in June, led the market-implied odds of a Fed hike to plummet from around 71% to 28%. With pressure from the rates space weighing on the dollar, all G10 currencies benefited, but a solid rally in crude to the $70 handle and limited movement in Canadian rates on the firmer prospect of a resumption in the BoC’s hiking cycle helped the loonie outperform. The only Canadian data released today was the S&P manufacturing PMI for may, which dipped to 49.0 from 50.2 in the previous reading. Today, all eyes are on the US, with nonfarm payrolls likely to drive the volatility in USDCAD.


Underpinning the dollar’s surge over the course of May was stronger US economic data, especially in the form of consumer spending. This led markets to price out imminent rate cuts from the Fed and even begin betting on a higher terminal rate in the form of a hike at either the June or July Fed meeting. However, in recent days, this narrative has been stress tested. Firstly, prominent Fed members have reiterated that the central bank’s preference to observe the transmission of previous policy tightening is stronger than markets have discounted. Meanwhile data yesterday in the form of Challenger job cuts and the final reading of Q1’s unit labour costs ahead of a weak ISM manufacturing PMI print really shone a light back on the weaknesses within the US growth profile and the potential for faster disinflation. While the collective data undermined hawkish Fed bets, it was really the unit labour costs that did the damage after the Fed had recently stressed the importance of this measure given its more holistic view on wage pressures. Being revised down over two percentage points from 6.3% to 4.2% in the final reading, the data not only reduces the need for further rate increases but also underscores the caution amongst some FOMC members to respond to some signs of inflation persistence within the economic data.

While pricing of the Fed’s next steps has come down significantly in recent days, the 30% implied probability of a hike at June’s meeting still remains too high in our opinion. May’s nonfarm payrolls data this afternoon at 13:30 BST will need to be exceptionally hot to bid these odds back up towards the near 50% mark they traded at the beginning of the week, especially given the rhetoric from the Fed remains much more sanguine. Expectations are for the labour market to add 195k jobs, the unemployment rate to tick up slightly higher to 3.5% and for the pace of average hourly earnings to mean revert to its Q1 average of 0.3%. If met, we think this kind of jobs report will result in continued USD depreciation heading into the weekend.


The single currency posted a rally yesterday, something of a rarity in recent weeks, rising against the USD by almost 0.70%. This was driven a dovish repricing in US rates, which somewhat normalised the recent decline in the ECB’s implied terminal rate, the main source of euro downside this week. This all occurred despite preliminary May inflation data for the eurozone confirming what the Spanish, German and French publications have been telling us in recent days: inflation is starting to slow across all major aggregates, including core services. While core inflation as a whole fell from 5.6% to 5.3% year-on-year, 0.2 percentage points below expectations, goods inflation fell from 6.2% to 5.8% year-on-year and services inflation from 5.2% to 5% year-on-year. This decline took with it the rationale that disinflation in the core measure was solely driven by core goods, something ECB officials had been fervently clinging to in recent communications. In our view, the latest round of data implies that the ECB is unlikely to raise the deposit rate above 3.75%, greatly reducing the likelihood of a hike in September. However, we believe it is too early to think that the ECB will pause it’s hiking cycle sooner. Indications so far are that ECB policymakers are not entirely comfortable with the idea that a disinflation process is in full swing. In particular, comments by ECB President Lagarde, speaking shortly after the inflation data was published, said “we have to continue our hiking cycle until we are sufficiently confident that inflation is on track to return to our target in a timely manner”. Accordingly, we stand firm in our forecast that the ECB will reach a terminal deposit rate of 3.75%, with 25 basis point hikes in June and July. For euro traders today, all eyes are on the US jobs report this afternoon. Signs that the labour market continued to cool will only weigh further on US rates and will likely take EURUSD back above the 1.08 handle.


The pound rallied almost three quarters of a percent against the dollar over the course of yesterday’s session, whilst also touching year to date highs versus the euro before retreating again to end the day flat. With limited data out of the UK, the move higher in the pound was once again fuelled by developments stateside. But, that shouldn’t detract from the dovish repricing in the UK rates space. Having initially jumped in response to hotter than expected CPI data, hawkish pricing of the BoE’s policy path was weighed down yesterday by concerning UK housing market data. Data from Nationwide showed the average property price in May was 3.4% lower than a year ago, marking an acceleration in the fall from April’s 2.7% decline. With rising mortgage costs the prime culprit for the house price decline, and with quoted rates ratcheting higher following the latest inflation release, the decline in prices looks set to persist. For individuals re-mortgaging, this provides a dual blow as the fixing rate rises alongside their loan-to-value ratio.

While recently a moderation in BoE expectations has supported the pound as it reduces the risk that the UK is once again flirting with a recession, yesterday’s repricing in rates likely had a limited impact. We expect this dynamic to continue as rates are currently at a neutral level in terms of providing a positive carry effect and a negative impact on prospective returns. Today, in the absence of any UK specific releases, the emphasis for the pound will once again be on the US with May’s Nonfarm payrolls data due out this afternoon.

FX Elsewhere

Rallying just over a percent against the dollar yesterday following weaker-than-expected US data and the subsequent decline in Treasury yields, the Australian dollar was the best performing currency amongst the expanded majors. The feel-good factor continues this morning, with AUDUSD trading 0.65% higher heading into the European open. Driving the rally overnight was the decision by Australia’s Fair Work Commission to raise the minimum wage by 5.75% this year, leading markets to price in higher odds that the RBA hikes rates at next week’s meeting. Still, with only 10bps worth of rate rises priced into Australian swaps, our call for a 25bps hike in the Cash Rate Target next week remains off-consensus. Should the RBA fulfil our expectations, the Aussie dollar is likely to further extend its recent rally, retracing what was a fairly dreary May.




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