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Markets seem to be trusting the ceasefire between Iran and Israel, and the dollar is back to testing its lows. Expect US data to play a bigger role from here, especially since Fed Chair Powell's cautious stance during his Congressional testimony included some subtle dovish hints. Dollar downside risks persist.

USD: Powell’s bullet dodged, at least partly
 

Geopolitical risk has continued to diminish for markets, as the Israeli-Iranian truce has held since yesterday morning. Markets will be assessing the stability of the ceasefire in the coming days, but are clearly biased towards playing the optimistic trade, judging by how quickly the oil premium has evaporated.

We believe that the negative impact of the reduced geopolitical risk on the dollar has largely played out. From here, further USD losses may need to be justified by US-specific factors: data, Fed, Trump's spending bill and tariffs. Yesterday, the first of these two factors was in focus, and while a surprise drop in consumer confidence is unequivocally negative for the dollar, Fed Chair Powell's testimony was a more nuanced event.

Powell reiterated caution on easing, and implicitly kept rejecting Trump's pressure, but also seemed modestly more open to discussing the conditions for starting cuts. Markets were actively searching for any minor signs of a dovish tilt after Waller and Bowman's calls for a July cut, and felt Powell's wording was enough, judging by the positive reaction in Treasuries. Is this negative for the dollar? We aren't convinced. There is a sharply USD-negative scenario where the Fed turns more abruptly dovish and markets doubt Fed independence. But in that scenario, Treasuries would come under pressure.

Instead, if Powell's communication allows only a moderate dovish repricing without signalling that he is bending to political pressure, the damage to the dollar can be limited. There is also a possibility that a slightly more dovish but firmly independent Fed ends up helping the dollar by helping Treasuries. Short-term rate spreads tell a small portion of the story in FX, while longer-dated yields are scrutinised much closer.

We’ll see the second part of Powell’s testimony today, while the data calendar only includes housing data for May. We could see some stabilisation in the dollar, but risks remain tilted to the downside.

Francesco Pesole

EUR: Testing the big resistance
 

The EUR/USD rally stalled again in the 1.160-1.165 area and it is plausible markets may require a more compelling macro story (most likely from the US) rather than the mere unwinding of geopolitical risks for a break higher.

A lot of focus in Europe is on the ongoing NATO summit in the Netherlands which Trump joined yesterday evening. Any signs that the US safety guarantees for European allies are faltering further – or becoming even more transactional than expected – can sour some sentiment in European markets. Especially after Spain’s refusal to meet the 5% defence spending target has curbed any enthusiasm for a coordinated spending boost.

That said, EUR/USD remains predominantly a dollar story, and the market’s blatant disliking of the greenback – confirmed by limited gains during the Middle East turmoil – means the upside potential remains intact.

Francesco Pesole

CEE: Returning to the local story
 

CEE currencies reacted positively yesterday to the announced ceasefire in the Middle East, and our bullish view paid off. In USD-crosses, all three major currencies in the region gained at least 1.0% this week alone and we can now see some stabilisation with more attention to the local story.

Today's calendar is quiet in the CEE region and attention will be on the Czech National Bank meeting. It should support the CZK with a hawkish tone, reacting to the growing upside inflation risks. Similarly, yesterday's meeting of the National Bank of Hungary was hawkish according to our expectations, which accelerated HUF gains.

In general, we remain bullish on the region but the next few days should be calmer unless the geopolitical situation changes again. While HUF and CZK have room for further gains, PLN may hit some limits. Yesterday's data brought another wave of PLN rate receivers, undermining the rate differential that made us bullish on the currency in previous days. Overall, we believe that EUR/HUF may test 400 in the coming days thanks to NBH support, EUR/PLN will be more limited on the downside at 4.250 levels.

Frantisek Taborsky

CZK: CNB will begin an infinite pause
 

The Czech National Bank will leave rates unchanged at 3.50% today, in our view, in line with market expectations. The decision should not be a surprise given the clear communication from the bank board in the previous days and we will probably see a clear vote split of 7-0. Today's meeting is without a new forecast and the bank board will therefore want to wait until August. However, we believe that inflation risks are building to the upside, and June and July, in particular, will see strong numbers that will keep the CNB on the hawkish side for a longer period, and we do not expect any rate cuts this year.

The market has reassessed bets on rate cuts, especially after May's inflation, and has moved the priced terminal rate from 2.75% to the current 3.25% or so. Even that seems too much to us given the likelihood that the CNB will return to rate cuts. Although we will probably not hear the end of the rate-cutting cycle announcement today, the tone should be hawkish, calling the last rate cut into question. We remain bullish on the CZK despite the rally over the past two days and expect EUR/CZK to head towards 24.70 today.

Frantisek Taborsky

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