EUR
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The ECB used the April meeting as a place holder meeting for the most part by not announcing any additional policy tweaks. The plans to phase out the APP into Q3 remained intact by reducing purchases from 40bln to 30bln in May and then down to 20bln in June. Markets were leaning towards a slightly more hawkish take from the bank (given recent inflation pressures), but the lack of conviction to remove the conditionality regarding the APP removal was seen as dovish. President Lagarde added to this dovish tone by explaining that Q3 has three months and IF the bank stops the APP, it could happen July, August or September. This was an important statement as the difference between a July and September end could mean the difference between a Q3 or Q4 rate hike. The president also added to the dovish tone by stressing that risks for the economic outlook are tilted to the downside and have recently intensified with geopolitical and virus-related challenges. When asked about policy normalization, the president made a strange comment by saying it is premature to think about monpol normalisation. As the bank is currently embarking on normalization this comment seemed out of place and reaffirmed the overall dovish take from the meeting. There were the usual sources releases after the presser which said policymakers see a July hike as still possible after Thursday's meeting, which provided some reprieve. With inflation >7% and growth slowing, the June meeting which accompanies staff economic projections will be critical for markets to solidify whether expectations of 1 or 2 hikes this year is correct or not.
2. Economic – Health – Geopolitics
Growth differentials still favour the US over EU capital flows, but differentials have turned positive and remain positive against the UK. Given growing stagflation fears the ECB is in a tough spot, being forced to normalize policy to try and combat inflation but could as a result further damage growth. Ongoing EU fiscal discussions to possibly allow ‘green bonds’ NOT to count against budget deficits remains in focus, alongside debt issuance for energy purchases. If approved, it will offer a flood of fiscal support which would be positive for the EUR and EU equities. Geopolitics remain a focus point as well given the ongoing war in Ukraine, but after the initial geopolitical scares but have been trying to carve out a base. Proximity to the war and the impact of sanctions remains a risk if the situation deteriorates. With lots of negatives already priced, chasing lows on bad news is not as attractive as chasing the EUR higher on good news.
3. CFTC Analysis
Another very bullish signal with all three major categories seeing another week of net-long weekly changes. It seems as if all three categories added longs at the worst possible time last week as the EUR failed to garner much upside momentum. With recent growth & inflation differentials turning in favour of the EUR we prefer trading the EUR higher on good news as opposed to chasing it lower on bad news right now.
4. The Week Ahead
The main event for the EUR in the week ahead will be the ECB policy decision. However, after the flurry of comments from various ECB members over the past few weeks, the meeting is not likely going to offer many surprises or fireworks, unless President Lagarde messes up her communication again. Markets are already pricing in 4 hikes (100bsp of tightening) by the end of the year, with a 25bsp hike in July and September fully priced. Thus, the focus will more likely shift to what happens after September, whether there is any specific mention that rates could rise above 0% by the end of the year. Furthermore, with inflation where it is, there has been some ECB members who have been hinting that a 50bsp might be up for discussion. This seems unlikely to be an option that the GC would want to go for at this stage but is a key risk we need to build into our scenario planning. Any comments from Lagarde that suggests a 50bsp could be possible in July would arguably be enough to give the EUR a bit of a lift. What the bank has to say about the recent move in Bund yields, and more specifically the climb in things like BTP/Bund spreads, will be important as well. With inflation as big of a problem as it Is right now, they can’t afford to stop their hiking posture just to save spreads (even though they are important). Thus, being on the lookout for her comments on the spreads will be important, especially if the bank might be contemplating a new type of tool(s) to ease some of the issues with the widening spreads. The other driver to watch in the week ahead is the USD. As close to 60% of the DXY has a EUR weighting, any big fluctuations in the Dollar as a result of the US CPI print needs to be kept in mind for the EUR in general in the week ahead. Even though geopolitics have not really been a big EUR mover, we should keep geopolitics in the back of our min as a possible short-term catalyst for the EUR.
USD
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
In May the Fed delivered on hawkish expectations by hiking the Fed Funds Rate by 50bsp and also confirmed that the committee expects further 50bsp hikes to be appropriate. The fed also stuck to a familiar hawkish tone by downplaying the prospects of an imminent recession by explaining that even though the economy contracted in Q1, that household spending and business investment remained strong. The Chair also stuck to their guns regarding the rate path by suggesting that they think reaching neutral (currently estimated at 2.4%) before year-end would be appropriate and will assess the need for further hikes when they get there. There were however some less hawkish elements which saw a very classic ‘sell-the-fact’ reaction in major asset classes. The first one was on the Quantitative Tightening front where the bank decided on a phased approach for balance sheet reduction by starting the monthly caps at 30bn (treasuries) and 17.5bn (MBS) and pushing it up to the expected $60bn (treasuries) and $35bn (MBS) over a three-month timeframe. The second less hawkish element was comments from Chair Powell who took 75bsp hikes off the table saying the committee was not actively considering rate moves of that size. Interestingly, it seems STIR markets did not really believe the Fed as the probability of a 75bsp hike stood at >70% directly following the presser. All-in-all, the meeting provided a short-term ‘sell-the-fact’ opportunity, but also cemented the view that despite signs of a slowing economy and despite clear stress in financial markets, the Fed is sticking to their aggressive tightening for now.
2. Global & Domestic Economy
The USD’s global usage means it’s usually inversely correlated to the global economy and global trade. The USD usually appreciates when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Expectations of a cyclical slowdown have been USD positive. However, we think a lot of the growth concerns might be reflected in recent USD appreciation already. Furthermore, the USD has not been responding positively to bad data like we’ve seen from the start of the year. More recently we’ve seen the USD depreciate on bad data which could suggest that the USD’s driver has temporarily shifted away from the growth focus and shifted towards a Fed focus as the worse the incoming data becomes the higher the likelihood of a less aggressive Fed in the months ahead. Incoming data will be watched closely in relation to the infamous ‘Fed Put’. If growth data slows but not enough to stop the Fed’s hawkish path it’s USD positive, but if the data cause a Fed pivot that’ll be a big negative for the USD.
3. CFTC Analysis
An overall bearish positioning change across major participant categories last week. Aggregate USD positioning remains close to 1 standard deviation above the mean, and close to prior tops where the USD topped out in previous cycles. That means we don’t want to chase the USD higher from here in the short-term.
4. The Week Ahead
We have shifted our bias for the USD from bullish to weak bullish based on the USD’s recent negative reaction to bad US economic data. If this trend persists, we could very likely be changing our fundamental bias for the USD to neutral. In the week ahead the main event in focus for the USD will be the May CPI data. It was clear from the past two CPI prints that we are likely past the peak in YY terms, but the peak is no longer enough to satisfy markets. From here the focus for CPI won’t only be on the declining level but also the pace at which it slows, which means monthly data points are very important as well. That means a lot of focus on how monthly CPI figures are impacted by big fluctuations in things like food, energy, and shelter prices. Both core measures are expected to slow again, while headline YY expected to stay flat, but a big acceleration expected for headline CPI due to recent upside seen in commodity prices. With markets already expecting a further move lower in the core components we will likely need a very significant miss to really ‘surprise’ markets. However, big surprise drops in both headline and core would still be expected to put pressure on the USD and US10Y while offering support for things like Gold and equities.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The ECB used the April meeting as a place holder meeting for the most part by not announcing any additional policy tweaks. The plans to phase out the APP into Q3 remained intact by reducing purchases from 40bln to 30bln in May and then down to 20bln in June. Markets were leaning towards a slightly more hawkish take from the bank (given recent inflation pressures), but the lack of conviction to remove the conditionality regarding the APP removal was seen as dovish. President Lagarde added to this dovish tone by explaining that Q3 has three months and IF the bank stops the APP, it could happen July, August or September. This was an important statement as the difference between a July and September end could mean the difference between a Q3 or Q4 rate hike. The president also added to the dovish tone by stressing that risks for the economic outlook are tilted to the downside and have recently intensified with geopolitical and virus-related challenges. When asked about policy normalization, the president made a strange comment by saying it is premature to think about monpol normalisation. As the bank is currently embarking on normalization this comment seemed out of place and reaffirmed the overall dovish take from the meeting. There were the usual sources releases after the presser which said policymakers see a July hike as still possible after Thursday's meeting, which provided some reprieve. With inflation >7% and growth slowing, the June meeting which accompanies staff economic projections will be critical for markets to solidify whether expectations of 1 or 2 hikes this year is correct or not.
2. Economic – Health – Geopolitics
Growth differentials still favour the US over EU capital flows, but differentials have turned positive and remain positive against the UK. Given growing stagflation fears the ECB is in a tough spot, being forced to normalize policy to try and combat inflation but could as a result further damage growth. Ongoing EU fiscal discussions to possibly allow ‘green bonds’ NOT to count against budget deficits remains in focus, alongside debt issuance for energy purchases. If approved, it will offer a flood of fiscal support which would be positive for the EUR and EU equities. Geopolitics remain a focus point as well given the ongoing war in Ukraine, but after the initial geopolitical scares but have been trying to carve out a base. Proximity to the war and the impact of sanctions remains a risk if the situation deteriorates. With lots of negatives already priced, chasing lows on bad news is not as attractive as chasing the EUR higher on good news.
3. CFTC Analysis
Another very bullish signal with all three major categories seeing another week of net-long weekly changes. It seems as if all three categories added longs at the worst possible time last week as the EUR failed to garner much upside momentum. With recent growth & inflation differentials turning in favour of the EUR we prefer trading the EUR higher on good news as opposed to chasing it lower on bad news right now.
4. The Week Ahead
The main event for the EUR in the week ahead will be the ECB policy decision. However, after the flurry of comments from various ECB members over the past few weeks, the meeting is not likely going to offer many surprises or fireworks, unless President Lagarde messes up her communication again. Markets are already pricing in 4 hikes (100bsp of tightening) by the end of the year, with a 25bsp hike in July and September fully priced. Thus, the focus will more likely shift to what happens after September, whether there is any specific mention that rates could rise above 0% by the end of the year. Furthermore, with inflation where it is, there has been some ECB members who have been hinting that a 50bsp might be up for discussion. This seems unlikely to be an option that the GC would want to go for at this stage but is a key risk we need to build into our scenario planning. Any comments from Lagarde that suggests a 50bsp could be possible in July would arguably be enough to give the EUR a bit of a lift. What the bank has to say about the recent move in Bund yields, and more specifically the climb in things like BTP/Bund spreads, will be important as well. With inflation as big of a problem as it Is right now, they can’t afford to stop their hiking posture just to save spreads (even though they are important). Thus, being on the lookout for her comments on the spreads will be important, especially if the bank might be contemplating a new type of tool(s) to ease some of the issues with the widening spreads. The other driver to watch in the week ahead is the USD. As close to 60% of the DXY has a EUR weighting, any big fluctuations in the Dollar as a result of the US CPI print needs to be kept in mind for the EUR in general in the week ahead. Even though geopolitics have not really been a big EUR mover, we should keep geopolitics in the back of our min as a possible short-term catalyst for the EUR.
USD
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
In May the Fed delivered on hawkish expectations by hiking the Fed Funds Rate by 50bsp and also confirmed that the committee expects further 50bsp hikes to be appropriate. The fed also stuck to a familiar hawkish tone by downplaying the prospects of an imminent recession by explaining that even though the economy contracted in Q1, that household spending and business investment remained strong. The Chair also stuck to their guns regarding the rate path by suggesting that they think reaching neutral (currently estimated at 2.4%) before year-end would be appropriate and will assess the need for further hikes when they get there. There were however some less hawkish elements which saw a very classic ‘sell-the-fact’ reaction in major asset classes. The first one was on the Quantitative Tightening front where the bank decided on a phased approach for balance sheet reduction by starting the monthly caps at 30bn (treasuries) and 17.5bn (MBS) and pushing it up to the expected $60bn (treasuries) and $35bn (MBS) over a three-month timeframe. The second less hawkish element was comments from Chair Powell who took 75bsp hikes off the table saying the committee was not actively considering rate moves of that size. Interestingly, it seems STIR markets did not really believe the Fed as the probability of a 75bsp hike stood at >70% directly following the presser. All-in-all, the meeting provided a short-term ‘sell-the-fact’ opportunity, but also cemented the view that despite signs of a slowing economy and despite clear stress in financial markets, the Fed is sticking to their aggressive tightening for now.
2. Global & Domestic Economy
The USD’s global usage means it’s usually inversely correlated to the global economy and global trade. The USD usually appreciates when growth & inflation slows (disinflation) and depreciates when growth & inflation accelerates (reflation). Expectations of a cyclical slowdown have been USD positive. However, we think a lot of the growth concerns might be reflected in recent USD appreciation already. Furthermore, the USD has not been responding positively to bad data like we’ve seen from the start of the year. More recently we’ve seen the USD depreciate on bad data which could suggest that the USD’s driver has temporarily shifted away from the growth focus and shifted towards a Fed focus as the worse the incoming data becomes the higher the likelihood of a less aggressive Fed in the months ahead. Incoming data will be watched closely in relation to the infamous ‘Fed Put’. If growth data slows but not enough to stop the Fed’s hawkish path it’s USD positive, but if the data cause a Fed pivot that’ll be a big negative for the USD.
3. CFTC Analysis
An overall bearish positioning change across major participant categories last week. Aggregate USD positioning remains close to 1 standard deviation above the mean, and close to prior tops where the USD topped out in previous cycles. That means we don’t want to chase the USD higher from here in the short-term.
4. The Week Ahead
We have shifted our bias for the USD from bullish to weak bullish based on the USD’s recent negative reaction to bad US economic data. If this trend persists, we could very likely be changing our fundamental bias for the USD to neutral. In the week ahead the main event in focus for the USD will be the May CPI data. It was clear from the past two CPI prints that we are likely past the peak in YY terms, but the peak is no longer enough to satisfy markets. From here the focus for CPI won’t only be on the declining level but also the pace at which it slows, which means monthly data points are very important as well. That means a lot of focus on how monthly CPI figures are impacted by big fluctuations in things like food, energy, and shelter prices. Both core measures are expected to slow again, while headline YY expected to stay flat, but a big acceleration expected for headline CPI due to recent upside seen in commodity prices. With markets already expecting a further move lower in the core components we will likely need a very significant miss to really ‘surprise’ markets. However, big surprise drops in both headline and core would still be expected to put pressure on the USD and US10Y while offering support for things like Gold and equities.
