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The dollar has had a good week ahead of the Memorial Day holiday, and we still think the USD/JPY currency pair can stay supported in the coming days. The EUR/USD and EUR/GBP pairs, however, look more likely to find some support than fall much further, as the ECB’s sanguine view on wages should not prevent further gradual shifts towards a less dovish narrative

USD: Growth Convergence Story Lost Steam

Hawkish Federal Reserve minutes and the consequent cooling off in global risk sentiment allowed for a moderate restrengthening of the dollar across the board on Friday, offsetting some domestic developments that – as in the case of the euro and the pound – pointed in the other direction. It should be noted that markets are closed on Monday for Memorial Day.

The data calendar has not been particularly busy in the US this week, although the positive surprise in the S&P Global PMIs endorsed the rebound in the dollar. Those are not as highly regarded as the ISM surveys, but have the benefit of being more easily comparable across markets.

The jump to 54.4 in the composite PMI puts the US back above the Eurozone (52.3) and the UK (52.8), denting the recent narrative of converging growth outlooks across the Atlantic.

Friday's key release in the US was April’s durable goods orders. We also saw the Kansas City Fed services survey later in the day. We don’t see a strong argument for directional changes in the dollar crosses over the short-term. Domestic stories should remain central amid a relatively quiet US calendar and the Memorial Day break.

We also maintain our bullish bias on the USD/JPY currency pair, as markets remained carry-oriented and the slowdown in Japan’s core CPI endorses the rather cautious pricing for further Bank of Japan rate hikes (25bp by year-end). Markets should continue to test Japan’s FX intervention tolerance, and a move to 158.0 looks very much possible in the coming days.

EUR: Some Hawkish Comments

Eurozone data has come predominantly on the hawkish side for the European Central Bank this week. Thursday's good PMIs pointed to further growth momentum, and negotiated wages surprisingly accelerated from 4.5% to 4.7% year-on-year in the first quarter.

The latter had long been seen as a make-or-break data point for a June rate cut, but ECB communication has now made a June move close to a done deal, and the ECB was oddly quick to publish a blog post to play down concerns on rebounding wages. The post stressed how one-off payments boosted the figure in the first quarter, and that a broader set of indicators point firmly to wage pressure deceleration in 2024.

The ECB’s “rectification” on wages means the chances of a rate cut being delayed beyond June remain small, even if next week’s CPI comes in a bit hotter than expected. At the same time, the chances of a more hawkish tone from the ECB at the June meeting have undoubtedly increased.

The main thing to watch in the Eurozone calendar on Friday were remarks from some of the ECB's hawkish heavy hitters: Isabel Schnabel, Madis Muller, and Joachim Nagel.

The EUR/USD currency pair was seen testing the 1.0800 support on Friday morning, and it remained predominantly driven by dollar dynamics. The next big event for the pair is in one week, with the US core PCE data print.

Given the risk of some hotter Eurozone inflation, and markets having shown a tendency to look on the brighter side of US price dynamics as of late, the coming days may revamp some bullish sentiment on the EUR/USD pair. A return to 1.0900 seems more likely than a drop to 1.0700 in the near-term.

GBP: EUR/GBP Appeared Cheap

The EUR/GBP currency pair recently found some support close to the key 0.8500 level and was trading on the strong side on Friday after UK retail sales came in lower than expected. The April print showed headline sales falling 2.7% year-over-year and the “ex-auto fuel” gauge -2.0%. March figures were also revised lower. The data followed a generally soft UK PMI report on Thursday, where the rebound in manufacturing failed to prevent a service-driven drop in the composite index to 52.8.

The pound is looking expensive vs. the euro at recent levels, in our view. The big hawkish repricing in the Sonia curve appears overdone, given the hotter-than-expected May services CPI is partly attributed to one-off factors, and we have seen signs of a dovish shift in the Bank of England’s MPC balance.

Markets are pricing in only 33 bp of easing by year-end and less than 10 bp for the August meeting. We still expect an August cut, and see any views for delayed easing due to the UK vote as misplaced.

Given the risks of the EUR/GBP short-term swap rate gap moving in favor of the euro (hawkish ECB cut and BoE cutting in August), and adding the risks of some small political risk premium being priced into sterling ahead of the July vote, we remain comfortable with our view that EUR/GBP pair will be heading higher beyond the short-term.

CEE: Forex Remained Sensitive to Sell-Off

As expected, Turkey's central bank left rates unchanged at 50% on Thursday while retaining a tightening bias in forward guidance. The CBT also announced macro-prudential and liquidity tightening moves following the recent developments in credit growth and deposits and to mop up excess liquidity in the system.

Our forecast here remains unchanged, with expectations of a first rate cut at year-end. In Poland, retail sales data disappointed in April after stronger industry data released on Wednesday. Overall, however, we remain optimistic about a recovery in the second quarter.

The end of the week in the CEE region was rather quieter compared to previous days. The calendar will only offer data from the Hungarian labor market. In the Forex market, after Wednesday's sign of weakness in regional currencies, Thursday saw a return to stability. However, we remain alert and open to possible further weakness in the region in the days ahead. The earlier rally seems to us to have left CEE foreign exchange overbought and vulnerable to profit-taking deepening any losses.

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