The dollar is advancing for a fourth session and Treasury yields are coming under pressure as uncertainty surrounding European political upheaval intersects with broader concerns over US policy direction heading into tomorrow’s inflation data and Federal Reserve meeting. North American equity futures are setting up for a weaker session and risk-proxy currencies like the Canadian dollar are drifting lower.
The British pound is trading with a weaker bias after a softer-than-expected labour report helped firm odds on an easing in monetary policy by the autumn. According to the Office for National Statistics, unemployment climbed to a two-and-a-half year high at 4.4 percent in the three months ended April, and private sector wage gains rose 5.8 percent year-over-year – the slowest in two years. A rate cut from the Bank of England is now fully priced in before November, with odds on a second move approaching coin-toss levels.
Implied volatility on the pound remains relatively subdued, with the upcoming election considered something of a fait accompli for Kier Starmer’s Labour Party. Somewhat unusually, the option term structure – which measures market expectations for volatility over time – points to greater concern about the political situation in Europe than in the UK, with one-week expiries trading at elevated levels.
After the weekend’s European Parliament elections triggered a snap poll in France, near-term volatility expectations for the euro have risen sharply, driving the common currency toward its biggest two-day loss since last September. Intra-euro spreads have widened, with yields on French debt pushing well above their German counterparts as markets brace for uncertainty during the first and second voting rounds scheduled for June 30 and July 7. Odds on a rate cut at the European Central Bank’s July meeting have risen modestly.
But the euro area is hardly facing an existential crisis. Although “far right” parties (many of which would seem relatively tame in the US political context) gained ground in the weekend’s elections, voter turnout was extremely limited and centrists remain in firm control at both bloc-wide and country-specific levels. Many of the indicators we watch most closely are pointing to a continued economic recovery ahead, and stubborn price pressures could yet force the European Central Bank to signal a slower pace of easing – President Lagarde yesterday warned markets not to imagine that “interest rates are on a linear declining path”. Options markets are still convinced that currency risks are skewed to the upside, with strikes above the 1.10 euro-to-dollar threshold trading at a premium to their counterparts on the weaker end of the spectrum.
Mexico’s peso is drifting higher this morning, but remains distinctly depressed after the country’s president-elect appeared to confirm her support for reforms that are widely believed negative for the business environment. Against our expectations, Claudia Sheinbaum failed to dial down the rhetoric in a press conference last night, triggering another circa-1.7-percent fall in the currency by saying “there should be a wide discussion in the months before the new Congress begins,” and keeping the elimination of a number of independent regulatory bodies on the agenda for later implementation.
The peso-dollar exchange rate is down more than 7 percent from pre-election levels, and near-term direction remains difficult to foresee. We think carry trade flows will ultimately boost inflows, but if the incoming administration continues to show signs of sticking to the reform agenda set out by previous president Andrés Manuel López Obrador, and the Bank of Japan makes more tightening noises, the peso could potentially fall back through the 20-to-the-dollar threshold.
Ten-year Japanese government bonds are yielding more than 1 percent in the run-up to Thursday’s central bank meeting. Policymakers are expected to leave their main policy settings unchanged, but could hint at raising rates at their next meeting, and might begin reducing asset purchases from current levels at roughly 6 trillion yen a month. We think officials will attempt to address recently-expressed concerns about wage hikes and currency pass-through effects by hiking rates again in July, with the next move following in early 2025 when another round of wage negotiations concludes. This outlook suggests that yields could hold above the 1-percent threshold for a prolonged period of time, squeezing carry trade flows, but not eliminating them.
Tomorrow’s US inflation report is expected to show price growth slowing, but with a slew of recent data releases pointing to still-resilient consumer demand, uncertainty levels remain elevated. Our calculations, derived from data released on Friday, suggest that US household net worth increased by an astonishing $50.3 trillion in the five years ended in the first quarter – only slightly below the gain seen in late 2021. We suspect that “wealth effects” – the idea that people spend more when the value of their assets increases – remain enormously important in the American economy, influencing everything from excess early retirements to the level of household demand. If so, the impetus behind labour market tightness and high consumer spending could take longer to subside.
