A Hawk Among Doves
- USD has bounced-back underpinned by widening monetary policy divergences. We expect the Fed to deliver a hawkish hold Wednesday.
- EUR and French bonds underperform following the outcome of the European Parliament elections.
- Sweden’s economy shrinks in April. Norway’s May CPI report was mixed.
Please see our Drivers for the Week Ahead for an in-depth look at what markets are facing this week.
USD is flexing its muscles underpinned by widening monetary policy divergences. The resilient US job market and strong services sector growth momentum suggest the Fed will not be in any rush to loosen policy. In fact, we expect the Fed to deliver a hawkish hold Wednesday. In contrast, other major central banks have started easing. Both the Bank of Canada and European Central Bank (ECB) slashed interest rates last week.
Following Friday’s stronger-than-expected non-farm payrolls report, Fed funds futures pushed-out the pricing of a first rate cut from September to November and trimmed the probability of two rate cuts in 2024 from almost 100% to 72%. The New York Fed’s May inflation expectations survey is today’s data highlight (4:00pm London).
EUR is underperforming following the outcome of the European Parliament elections. As polls suggested, the nationalist/populist parties [Identity and Democracy (ID) and the more moderate European Conservative and Reformists (ECR)] made important gains and could play kingmakers in the new parliament. This could complicate or delay the progress towards deeper Eurozone integration.
Regardless, it may take weeks before political alliances are shaped and a centrist “super grand coalition” remains the most likely scenario. The centre-right European People’s Party (EPP) are still the parliament's biggest group followed by the centre-left Socialists and Democrats (S&D), and the centrist Renew Europe (RE).
French President Emmanuel Macron’s decision to call snap legislative elections on June 30 with a second round on July 7 reflects his party’s trouncing in the European Parliament elections. France’s hard right National Rally (NR) party came out on top, and the likelihood is they replicate this win in the French National Assembly in the upcoming legislative elections. If so, Macron would become a lame-duck president with three years left to his term. The ECB’s policy outlook will remain a bigger driver of EUR than the Eurozone’s political landscape. As such, ECB/Feb policy divergence can further weigh on EUR/USD.
NOK ignored Norway’s mixed May CPI report. Annual headline CPI inflation slowed more than expected to 3% (consensus: 3.3%, prior: 3.6%) due to lower electricity prices. However, annual underlying CPI inflation was sticker than expected at 4.1% (consensus: 3.9%, prior: 4.4%) reinforcing the Norges Bank’s guidance that a tight monetary policy stance may be needed for somewhat longer than previously envisaged.
SEK weakened slightly following Sweden’s poor April GDP print. Real GDP fell 0.7% m/m after shrinking 0.4% in March on declining household consumption and private sector production. Weak economic activity supports the Riksbank’s guidance to cut the policy rate two more times during the second half of the year. Bottom line: NOK/SEK has scope to edge higher on diverging Norges Bank/Riksbank policy rate outlook.