The dollar has found broad-based support after US-Iran military re-escalation and data that keeps pointing to US economic resilience. It’s hard to find the trend in this environment. One week ahead of the ECB meeting, we see increasing risks of a hawkish hike, but a lack of progress in the Middle East might take EUR/USD to 1.150 before then.
USD: Stronger and stronger
It’s hard to argue against dollar strength at this juncture. Data continues to paint a picture of resilience for the US economy – ADP payrolls and ISM services were both firm yesterday – and fresh US-Iran military exchanges have driven a risk-off shift in global markets. Yesterday’s House resolution to end the war is meaningful, but it doesn’t block new military operations. It highlights domestic pressure for a peace deal, but markets already understand this, and it has not yet translated into tangible progress in negotiations.
The US data calendar is quieter today before tomorrow’s jobs report. Some focus will be on Challenger job cuts data for May or weekly jobless claims only if they show a meaningful acceleration. The Fed’s Beige Book released yesterday signalled a steady outlook for employment despite inflationary pressures.
A few dollar crosses are attempting to make decisive breaks away from key psychological levels. EUR/USD at 1.160, USD/JPY at 160.0, USD/CAD at 1.390. We think those breaks will come unless the next few days bring renewed optimism from the Middle East. The 100 mark in DXY looks within reach in the current environment.
EUR: Looking down
Our macro team has published an updated preview of next week’s ECB meeting. The call is unchanged and fully aligned with consensus and pricing: a 25bp hike. Our view is that the ECB will err on the hawkish side to keep at least one additional hike priced in and to safeguard inflation expectations.
Still, a week is a long time in the current environment. By the time the ECB delivers, a lack of progress in the Gulf may already have dragged EUR/USD back to 1.150.
Yesterday’s upward revision in the eurozone’s composite PMIs offered little reassurance to EUR bulls, which remain vulnerable to a deteriorating domestic outlook and softer global risk sentiment whenever hopes for a peace deal are pushed further out.
BRL: FX plays catch-up with rates
The stronger US rate/dollar environment is starting to prove a headwind for some of the more popular emerging market plays, including the Brazilian real carry trade. USD/BRL is back to challenging last month’s highs near 5.08 and could be looking to fill a gap back to the 5.14 area. Beyond the strong dollar environment, the local story sees President Lula’s approval ratings continue to widen over Flavio Bolsonaro and Brazil having to deal with the renewed threat of 25% US tariffs.
In reality, however, it looks as though the Brazilian real is catching up with the local interest rate market, where short-dated rates have been selling off since late last week. At the start of the year, the market had been pricing the BACEN’s policy rate down at 12.50% from a 15.00% starting point. Now investors are considering the next BACEN move (off a 14.50% policy rate) to be a hike.
Barring a massive spike in US yields and the dollar, which is not our baseline scenario, we expect the BRL to find good support on any dips given its high yield and net energy exporter status. Maybe the correction to 5.14 will be sufficient.
CEE: Inflation may decide CNB June rate hike
The Czech Republic will release its May inflation figures today, and we expect some easing from 2.5% to 2.3%, in line with market expectations. Core inflation should also ease slightly from 2.9% to 2.8%. The CNB had expected 2.1% for May in its forecast, but April was already 0.1pp above the forecast. Core inflation was in line with the CNB's expectations, and it is also expecting 2.8% for May. However, food inflation in the Czech Republic has been an outlier with a decline in previous months and it is not clear where it is heading in May, with Poland and Germany showing declines compared to the previous month.
The print should receive more attention than usual given the hawkish repricing, with the market expecting a full rate hike in June from the CNB after several comments from the bank board. We would therefore expect the market to be more sensitive to downside surprises than upside surprises at this point given the hawkish pricing. EUR/CZK is testing levels below 24.200 as we discussed here yesterday, and CPI should decide the next direction today whether we settle below this level or not.
The governor of the National Bank of Poland yesterday gave a dovish tone after inflation surprised down on Friday last week. The current situation does not require rate hikes for now, according to the governor, but he is leaving the door open if oil prices jump up or the government lifts fuel price caps. But we also heard mention of slow wage growth and stable FX as reasons to wait. Our baseline remains no change in rates for a longer period. The zloty has seen less pressure to weaken but remains in the same range of 4.225-265 without a big story here.
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