FX Daily: Risk Assets Rally, Central Banks In Focus

Confirmation of a ceasefire has seen risk assets rally, while energy, interest rates and the dollar have fallen. Assuming the US-Iran peace deal gets signed this Friday, the focus this week will be on how central banks deal with the legacy issue of higher prices. Seven of the G10 central banks meet this week. Wednesday's Fed meeting can limit dollar downside.

USD: Dollar explores the downside

News of a US-Iran ceasefire and, more importantly, news that the Strait of Hormuz is set to reopen have seen energy prices drop back to early March levels and equities enjoy a decent rally around the world. Financial markets have had opportunities to react to this kind of deal on several occasions already, and the MSCI World Index is already 5% higher than before the war. This suggests risk assets might not need to travel too far on today's welcome news. The bigger reaction could come at the short end of yield curves, where central banks have had to clear up the inflationary mess left by the energy spike in April and May.

On the subject of central banks, it is a big week for policy meetings. Seven of the G10 central banks meet this week, starting with Australia and Japan in early Asia tomorrow. The week then builds with rate meetings in the US, the UK, Norway, Sweden and Switzerland. The biggest focus this week, however, will be on Kevin Warsh's first meeting as Fed Chair. The market clearly expects a less dovish set of communications (with an easing bias and expected 2026 rate cut removed), but we suspect he will have to talk tough on inflation to avoid upsetting the long end of the bond market.

In terms of US activity data, Wednesday's May retail sales data is probably the most important. This will shed light on whether high energy prices have forced consumers to rein in spending on other items and build the narrative of US businesses having little pricing power after all.

Today's DXY drop has been quite modest so far. There is outside risk to the 99.00/99.15 area, but Wednesday's FOMC event risk probably limits a further sell-off just yet.

EUR: Focus on ECB speakers this week

Following last week's ECB rate hike, the focus this week will be on whether and when it needs to follow up with a second. There are ECB speakers scheduled every day this week, starting with Joachim Nagel and Christine Lagarde this morning. Presumably, the ECB will want to keep all its options open, but it finds itself in a more comfortable position now that the market prices only a 16% chance of a rate hike in July.

The EUR/USD rally has been less than impressive so far, and it is not clear that it needs to trade above 1.1650 today.

Looking across the rest of Europe this week, sterling could face some downside risks if the Bank of England is not hawkish enough. Norges Bank will probably prove quite hawkish, while Sweden's Riksbank might be closest to the Canadian position in trying to look through any energy-driven inflation spike. The Swiss National Bank should be quite neutral, although EUR/CHF could come lower if short-dated yields drop much further on the back of energy.

GBP: A few sterling risks this week

The Bank of England meets on Thursday. Markets have pushed back expectations of the first Bank of England rate hike until the November meeting. Lower energy prices can prompt questions about whether the BoE needs to hike at all, and Governor Andrew Bailey will have to walk a fine line this Thursday. Thursday also sees the Labour by-election in Makerfield. A victory by Andy Burnham would formally fire the starting pistol on the Labour leadership contest and likely weigh on sterling.

EUR/GBP is currently holding strong support in the 0.8610/15 area, and we would expect that to hold this week.

CEE: The region remains driven by global headlines

The regional calendar is rather light this week. Today, Poland will publish its final inflation figures for May, which should confirm a 3.1% reading. On Tuesday, core inflation figures will follow, which we believe increased only slightly from 3.0% to 3.1%. On Wednesday, Hungary will publish wage figures. On Thursday, we believe the Czech National Bank will raise rates from 3.50% to 3.75% as the first step in tightening since the start of the US-Iran conflict. Although headline inflation remains close to the 2% target (2.1% in May), the Bank Board is concerned about core inflation near 3% (2.9% in May) and rapid credit growth.

Given the developments in the US-Iran conflict and the Fed meeting this week, attention will likely be mainly on the global story. CEE currencies saw some relief at the end of the week, and further direction will depend on global sentiment, which – at least for Monday – indicates a risk-on mood. The Czech koruna should have some additional support thanks to the CNB's hawkish tone, and EUR/CZK could test 24.00 later. On the other hand, we see that a lot of good news is priced into the CEE and risk assets in general, which leaves the region exposed if the global story turns once again.