News & Analysis


Sterling started yesterday’s session on the defensive against both the dollar and the euro as overnight interest rates in the UK drifted higher across the SONIA curve after news that a fire in a Texas LNG terminal would likely disrupt UK gas imports for up to three weeks. The higher interest rates matched the spike in UK gas futures, adding to bearish sentiment around the pound as inflation pressures intensified. While the pound clawed its way back against the euro as the ECB sent the single currency plummeting, it closed out the day 0.34% lower against the dollar. Speaking in Blackpool, Prime Minister Johnson’s “reset speech” alluded to future income tax cuts, suggestions of corporate tax cuts to boost productivity, the need for more 95% mortgages, and reducing tariffs on food imports. However, despite the headlines that further support for households during the cost of living crisis is in the pipeline, sentiment remained too shattered for the bruised pound to price higher.


The single currency broadly strengthened heading into yesterday’s European Central Bank meeting at 12:45 BST. Upon release of the rate statement, EURUSD quickly reversed its daily gains as traders unwound the light positioning for a rate hike as early as this week while also pricing out the probability of a larger-than-25 basis point hike in July. Shortly afterwards, however, EURUSD began to rally yet again as the focus shifted towards September’s meeting and beyond, where the ECB rate statement highlighted their base case is to raise rates by more than 25bps if the inflation outlook deteriorated or even persisted. This solidified our base case expectation: the central bank would conduct a milder lift-off of 25bp in July before looking to front-load their hiking cycle in September with a 50bp hike when inflation pressures are expected to peak. The hawkish undertones of the rate statement meant EURUSD continued to rally into President Lagarde’s press conference at 13:30 BST. After which, the going got tough for the EUR bulls who betted on the prospect of higher implied rates resulting in a sustainably stronger euro. While Lagarde’s commentary didn’t necessarily unwind pricing of a 50bp hike in September, despite her repeatedly caveating the hawkish guidance by saying policy would remain flexible and that the central bank is vying for complete optionality, it was instead the blowout in peripheral bond spreads that sent the euro plummeting. The spread between German and Italian 10-year yields increased by a further 14.5bps, the third-largest one-day widening in the spread since April 2020, to hit its widest point since April 2020. In doing so, concerns over financial stability and debt sustainability in more exposed eurozone nations increased, eventually weighing on the prospect of how high the ECB could lift rates before this restriction bound. Without announcing a new market fragmentation policy tool, the ECB’s actions failed to get markets to do their dirty work for them. Higher interest rates were priced in, but this came at the cost of higher lending rates in some eurozone nations, which will restrict growth, along with a weaker euro on the back of the bond developments that only exacerbates the euro-area’s inflation problem. This morning, the Financial Times quotes one un-named dovish ECB member in saying “my impression is that everyone lost” with regards to yesterday’s meeting. Well, everyone except those that were short Italian BTPs and EURCHF. The franc, which is our favoured regional safe haven, rallied over 0.6% against the euro on the back of widening peripheral spreads. Today, the ECB will likely be in damage limitation mode, with French Governor Francois Villeroy already stating that the ECB has the will and means to tackle market fragmentation when speaking on French TV. At 09:00 BST, Austrian Governor Holzmann is set to speak, while Bundesbank Nagel is scheduled for 16:00 BST. As is the case with the ECB, unscheduled headlines are also likely, especially as back-end spreads continue to widen this morning.


The greenback remained dominant in yesterday’s market as it rallied against all G10 currencies. EURUSD price action called the tune for the broad dollar in yesterday’s session, similar to how USDJPY dictated the tone on Wednesday. With rising eurozone yields dragging Treasury yields higher and a plummeting EURUSD, which accounts for over half of the broad dollar DXY index, markets succumbed to trading a stronger dollar across the whole of the G10 currency board. Today, the tone is different within the G10 space as risk-sensitive currencies, like AUD and NZD, trim yesterday’s heavy losses overnight as Chinese equities posted a modest bounce and US equity futures trade in the green. The mild dollar decline could be extended later on in today’s session, depending on how May’s CPI data prints at 13:30 BST. At 8.3% YoY, headline inflation in the US was expected to have peaked in April, but the consensus estimate has slowly nudged upwards over the course of the week to sit at 8.3%, suggesting that markets may not see the first signs of disinflation in the US just yet. With the range of inflation expectations broadly split, risks are two-sided for the dollar.


The Canadian dollar shifted over a percentage point against the dollar yesterday as the Bank of Canada’s financial stability review pushed front-end Canadian bond yields lower as it stressed the vulnerabilities in the Canadian housing market. Coupled with rising US Treasury yields and further pressure on North American equity indices, the global market backdrop created the perfect storm for renewed depreciation in the Canadian dollar. Today will be another decisive day for the Bank of Canada’s interest rate outlook as May’s labour force survey is released. With job gains grinding substantially slower as the unemployment rate prints at historic lows, higher wage growth and reduced underemployment will be sought after to see how the tight labour market threatens to generate persistently high inflation pressures. Additionally, US CPI data for May is released at the same time, meaning 13:30 BST will likely be the crunch point for USDCAD in the near term.



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