US
USD is holding on to most of yesterday’s dip triggered by political jawboning over a potential US-Iran peace deal. President Donald Trump said the US is in the “final stages” of negotiations with Iran. Today, the semi-official Iranian Students’ News Agency reported that the latest US proposal “has narrowed the gaps to some extent.”
Nevertheless, resilient US economic activity which backs a more restrictive Fed outweighs the drag to USD from improving sentiment tied to the Iran war. We are sticking to our view the dollar index (DXY) risk overshooting the upper end of its nearly one year 96.00-100.00 range in the near-term.
The FOMC April 28-29 meeting minutes supports Fed funds futures pricing odds (70%) of a 25bps rate hike by year-end. According to the minutes “A majority of participants highlighted…that some policy firming would likely become appropriate if inflation were to continue to run persistently above 2 percent.” With the underlying disinflationary trend stalling, the bar for a rate hike is lower.
The US May PMI is today’s data highlight (2:45pm London, 9:45am New York). The composite PMI is seen rising to 51.8 vs. 51.7 in April. Initial jobless claims for the week ended May 16 is also due and expected to remain consistent with limited signs of a broad-based layoffs (1:30pm London, 8:30am New York). Finally, we get a fresh update of the Atlanta Fed GDPNow model, which currently estimates annualized real GDP growth of 4.0% in Q2 vs. 2.0% in Q1.
EUROZONE
EUR/USD is holding above 1.1600. We see room for EUR/USD to edge lower towards support at 1.1400, reflecting a stronger US growth outlook relative to the Eurozone.
The Eurozone May PMI indicates a deeper downturn in economic activity. The composite PMI unexpectedly dropped -1.3ppt to a 31-month low at 47.5 (consensus: 48.8) driven by further decline in the services PMI (-1.2ppt to 46.4, 63-month low) and slower manufacturing growth momentum (-0.8ppt to 51.4, 3-month low). France's private sector economy suffered its sharpest contraction in 66-month, while the contraction in Germany eased marginally.
Markets continue to price in 86% odds of a 25bps ECB rate hike to 2.25% at the June 11 meeting. Rate hikes in a low growth, high inflation environment, is not outright bullish for EUR but should help cushion the downside.
UK
GBP/USD is consolidating around 1.3440. However, scope for a downward adjustment to the UK swaps curve alongside the rising likelihood the Labour government pivots further leftwards can further undermine GBP.
The UK May PMI points to a contraction in private sector activity. The composite PMI unexpectedly plunged -4.1ppt to a 13-month low below the 50 boom/bust level at 48.5 (consensus: 51.6) driven entirely by the services sector. The services PMI declined -4.8ppt to 47.9 (consensus: 51.7), the lowest since January 2021, while the manufacturing PMI was unchanged at 53.7 (consensus: 53.0).
The swaps curve trimmed BOE rate hike expectation in the next twelve months to 57bps from 75bps. That’s still too aggressive given the BOE estimates a negative output gap between -1.5% and -1.7% of potential GDP in 2026.
JAPAN
USD/JPY is holding around 159.00 and should hold under 160.00 due to threat of currency intervention. Japan’s May PMI points to slower private sector growth momentum. The composite PMI slipped -1.1ppt to a five-month low at 51.1 as services sector growth stalled and manufacturing growth lost traction.
Regardless, the Bank of Japan (BOJ) is turning more hawkish which is JPY supportive. BOJ board member Junko Koeda said she believes “it is reasonable for the Bank to raise the policy interest rate at an appropriate pace to address high inflation while also considering the trade-offs for the economy.” Last week, BOJ board member Kazuyuki Masu also signaled support for raising rates at “earliest stage possible…if statistical data do not indicate clear signs of an economic downturn.”
Both Koeda and Masu voted with the 6-3 majority to keep rates on hold at the last April meeting. As such, their remarks strengthen the case for a June rate hike especially given that three other BOJ members (Nakagawa Junko, Takata Hajime, and Tamura Naoki) dissented in favor of tightening in April. The swaps market firmed up odds of a 25bps BOJ rate hike to 1.00% for the June 16 meeting.
AUSTRALIA
AUD/USD dipped to intra-day lows near 0.7100 on disappointing Australian economic data. We expect AUD/USD to stabilize a bit lower around 0.7000, the level implied by Australia-US 2-year bond yield spreads.
Australia April labor force report was poor. The economy unexpectedly lost -18.6k jobs (consensus: +15k) vs. +23.3k in March driven by both full and part-time employment. The unemployment rate rose +0.2ppt to 4.5%, the highest rate since November 2021, exceeding market expectations of 4.3% and the RBA’s end-June projection of 4.2%.
RBA cash rate futures slashed rate hike odds and pushed out the timing of the next full 25bps rate hike from September to November. In our view, the risk is skewed towards a more extended pause in the RBA tightening cycle. First, the RBA projects real GDP growth to be below potential over the next two years. Worrisomely, the composite PMI dropped -2.6ppt below the boom/bust 50.0 mark to 47.8 in May. Second, the RBA cash rate at 4.35% currently sits near the top of the range of model-based central estimates of the nominal neutral rate.
