The dollar's prospects are looking brighter as we head into a pivotal week for economic data, particularly in the United States. There's a growing sentiment that US economic growth could accelerate once again, fueled by the ripple effects of AI investments across various sectors. The healthy job market and increasing pricing intentions indicated by the ISM business surveys suggest that the Federal Reserve may consider raising interest rates later this year. This anticipation has kept the dollar strong.
The Macro Story Takes Center Stage
While geopolitical tensions in the Gulf region have captured headlines, their impact on energy, equity, and FX markets has been minimal so far. The one-month G7 FX implied volatility has dipped to levels last seen in the summer of 2024, indicating that geopolitical factors are expected to play a less significant role in FX markets in the coming months. Instead, the focus is shifting back to US macroeconomic narratives.
This week will be packed with US job market reports and business surveys. The JOLTS job opening data for April, the monthly ADP reading, Challenger layoff data, and the highly anticipated May non-farm payrolls (NFP) data will provide a comprehensive picture of the US labor market. Additionally, the ISM business surveys for the manufacturing and services sectors, along with the Federal Reserve's Beige Book, will offer insights into employment trends, order books, and pricing power.
Fed's Focus Shifts to Inflation
The upcoming data releases are expected to further strengthen the narrative that the Fed can confidently fulfill its full employment mandate and turn its attention to the upside risks of inflation. Having heard from the most dovish Fed member, Michelle Bowman, the focus now shifts back to the hawks, with speakers like Neel Kashkari, Beth Hammack, and Lorie Logan taking center stage.
If the jobs data remains positive and price pressures indicated by the ISM surveys persist, markets may start pricing in a full 25bp Fed rate hike this year. This contrasts with the current expectation of +17bp of tightening. In an environment of low volatility, the carry trade is likely to remain attractive, and any dollar rally driven by stronger US activity data is more likely to be against low-yielding currencies like the Japanese yen and the Swiss franc.
Euro and Sterling: Navigating Expectations
In the eurozone, today's release of the ECB's wave survey of inflation expectations is a key event. A further spike in three-year CPI expectations could reinforce the view that the ECB will need to hike interest rates twice this year, probably in June and September. This would be more aggressive than the current market expectation of +44bp of ECB tightening by September. However, the euro's upside potential against the dollar is expected to be limited by the strong dollar narrative.
For the British pound, Bank of England Governor Andrew Bailey's recent comments have successfully subdued rate hike expectations for this year. The market now prices in just 33bp of BoE tightening, down from over 80bp at one point. The drop in oil prices has also played a role in this shift. Governor Bailey's stance suggests that the BoE could tolerate temporary above-target inflation as long as second-round effects do not materialize. Insights into these second-round effects may emerge this week from the BoE's Decision Maker Panel survey.
Central and Eastern Europe: Cautious Start
Central and Eastern European (CEE) markets open the month with a busy data schedule. May PMI readings so far indicate that the US-Iran conflict has not significantly impacted sentiment. The focus then shifts to the National Bank of Poland's meeting on Tuesday, where rates are expected to remain unchanged at 3.75%. Friday's softer-than-expected inflation print of 3.1% supports a hold, a stance Governor Adam Glapiński is likely to reiterate at the press conference on Wednesday.
On Thursday, the Czech Republic will report May inflation and first-quarter wage data, with headline CPI expected to ease to 2.3% year-on-year from 2.5% previously. Turkey will release inflation data on Friday, with consensus expecting a slight decline to 32.0% YoY from 32.4%.
With sentiment improving towards the end of last week but mixed headlines from the Middle East over the weekend, we anticipate a cautious start to trading in CEE today. Recent sessions have seen a notable pullback in rate hike pricing in Poland and the Czech Republic, while expectations in Hungary have shifted towards easing. In our view, there is room for further dovish pricing in Hungary, but limited scope for significant repricing in Poland and the Czech Republic.
EUR/PLN and EUR/CZK are trading near the lower ends of their recent ranges, but neither pair offers a compelling stronger-conviction story at this stage. EUR/HUF briefly tested its four-year low of 354 on headlines about the unlocking of EU funds, but any further gains are likely to be gradual, with 350 in EUR/HUF remaining our mid-year target.
Conclusion
As we navigate this crucial week for economic data, the focus is on the US macro story and its potential impact on the dollar. Geopolitical tensions seem to be taking a backseat for now, allowing markets to shift their attention to domestic economic narratives. The upcoming data releases will provide further insights into the trajectory of central bank policies, particularly in the US and Europe. It will be interesting to see how these developments shape currency markets and whether the dollar can maintain its strength.
