FX Daily: Focus Remains On Yen And Sterling

The options market appears to be pricing in a greater chance of imminent JPY FX intervention ahead of the US-Japan finance ministers' meeting. In the UK, sterling rallied on hopes that market-friendly Wes Streeting will become the Chancellor in a new government led by Andy Burnham. The dollar remains firm on the US-EU divergence narrative.

USD: Some upside risks persist

The dollar has firmed up in a risk-off-leaning start to the week for markets. US bond yields have continued to move higher, in dissonance with European rates. It’s a dynamic affecting the whole curve, which clearly underscores expectations of US divergence on growth, inflation and monetary policy – which are underpinning the current strong USD momentum. For now, we continue to see upside risks in the near term for the greenback.

The yen’s weakness remains firmly on the market's radar this week. Japanese Finance Minister reserve data showed a drop in US Treasury holdings in May of around $75bn, not far from the size of the April-May intervention ($73bn). This has raised some questions about potential unease at the US Treasury, which has been closely watching foreign selling.

That dynamic could argue for more patience before another intervention, but rising short-dated USD/JPY implied volatility suggests markets are increasingly positioning for renewed action. US Treasury Secretary Scott Bessent and Japan’s Finance Minister Satsuki Katayama are set to hold talks after Katayama said the two sides had agreed to take “bold steps” in currency markets. If the Bank of Japan sticks to its preference of intervening around holidays when liquidity is thinner, the period around 4 July (which is a Saturday) offers the next window of opportunity. But there’s a good chance it might act before.

US S&P Global PMIs are today’s main data release, and services are expected to show a modest improvement. With European PMIs out on the same day, the data could feed into the divergence narrative, although the releases are typically of limited market impact.

Fespeak remains a more interesting thread to follow this week. Today, we’ll hear from John Williams, who is a dovish-leaning voice and potentially among those projecting no hikes this year. Let’s see if he’s willing to give some pushback against a market fully pricing in two hikes by March 2027.

EUR: Lagarde’s dovish tilt softens euro

The euro came under modest pressure yesterday after ECB President Lagarde told EU lawmakers there is no need to step up the monetary response to the war, as she has confidence that inflation is headed back to the target in the medium term. It was a rare dovish-leaning comment, as the ECB has mostly tried to endorse the market's hawkish bets in the past three months.

Still, the dovish repricing was quite small (around 2bp in the 2-year swap rate), and a rate hike in 3Q remains largely priced in (19bp). Perhaps, Lagarde is attempting to make sure markets don’t attempt to price in a July move, whose implied probability dropped from 17% to 10% after her comments yesterday.

In any case, it’s hardly a positive development for the euro at a time when the dollar remains well-supported by both data and Fed communication (at least in-meeting). We still expect a test of 1.1400 in the near term.

Today, PMIs should show some marginal improvement thanks to lower crude prices, but growth concerns are likely to remain present and cap the rebound. Any substantial disappointment in PMIs would probably endorse a kind of “damage done” narrative that could keep the euro weaker for longer.

GBP: Growing bets Streeting will be next chancellor

After the resignation of Keir Starmer as prime minister, market attention has shifted to who will take the chancellor's role in the new government, which is almost certainly going to be led by Andy Burnham.

The pound had a decent run yesterday after former health secretary Wes Streeting – a centrist figure within Labour – announced he would back and not challenge Burnham’s PM bid. That could mean a quick transition, with Burnham potentially being coronated as the new PM as early as 16-17 July, and crucially prompted bets that Streeting will take the chancellor job. Streeting is generally considered a more market-friendly pick than Ed Miliband, reportedly the other main candidate for the job.

EUR/GBP erased the small 0.2% overvaluation we estimated it was holding before Starmer’s resignation – which we didn’t deem indicative of actual political risk premium – and is now trading around 0.3% below its short-term fair value. Sterling could see a further modest lift if Streeting is confirmed as chancellor, but risks from here look skewed to the downside. Markets appear optimistic about the transition, yet history shows that even limited budget concerns can trigger disproportionate moves in gilts and GBP.

Regardless of politics (rarely a sustainable driver of sterling), we keep favouring higher EUR/GBP on the back of a dovish view (no hikes) on the Bank of England, and expect a return above 0.870 this summer. UK PMIs today may show some improvement, but they typically carry limited weight for the BoE.

HUF: NBH easing restart unlikely to derail forint resilience

The National Bank of Hungary is likely to cut rates by 25bp to 6.00% today, restarting easing after February’s cut and the pause triggered by the US-Iran conflict. HUF has gained around 6.2% versus EUR since April’s general election and recently reached 350 EUR/HUF, our mid-year target. The REER is close to its 2008 highs, although HUF still looks cheap versus regional peers, leaving some room for further appreciation. On inflation, May surprised to the downside at 1.8% YoY, well below market and NBH expectations.

With the lowest inflation rate in the region and inflation below target, markets are pricing around 125bp of cuts this year and an NBH landing zone near 4.75% next year. This does not look stretched versus 2024 pricing, and we expect markets to price more cuts once easing resumes. With long positioning concentrated at the long end, we expect further near-term bull steepening. FX implications are less clear. Normally, rate cuts would weaken HUF, but current FX support comes from positive sentiment and strong demand for HUF assets after the April election. Cuts therefore do not necessarily imply weakness, especially with the market's already dovish pricing.

Still, deteriorating carry may reduce HUF’s appeal. We see this stabilising EUR/HUF rather than driving it much higher, with vol likely to compress. Any upward correction should attract fresh interest at higher levels; a stronger USD and NBH cuts could take EUR/HUF toward 355 in the short term, where resistance may emerge.