The USD continued to edge lower in May, giving up the last of the gains made since the US election, but the pace of decline was relatively slow and USD losses did not break through key levels. Trump’s policies, particularly on tax, remain important for the USD in the longer term, but the focus in June is likely to be more on the current economic situation in the US and abroad as well as the Fed and ECB policy stances given the economic news. However, US political uncertainty looks likely to be with us for some time and seems set to restrict the USD upside for now. In the UK, the General Election on June 8 will be the focus, with the latest polls suggesting much greater uncertainty about the result than initially seemed likely. There is also still some renewed concern about European politics after the relief following the French election, with Greek debt again in focus and the possibility of early Italian elections becoming more of an issue.
1) The Fed – June 13/14
Markets are projecting a 96% likelihood that the Fed meeting on June 13/14 will produce a 25bp rate hike. Consequently, there would be a bigger USD reaction if the Fed does nothing than if they produce the expected rate hike. If they do raise rates as expected, the USD reaction will depend on any indications they provide as to the future path of rates. However, the market is currently centered on the expected June hike being the last hike of the year (as around a 51% chance), so it will be hard for the market to reduce expectations of Fed tightening going forward if the Fed raise rates as expected, even if the commentary accompanying any Fed statement is not particularly hawkish. In practice, it is always hard for a Central Bank to raise rates and sound dovish – such mixed messages are generally seen as poor communication – so a rate hike should provide the USD with a modest boost.
Six-Month USD Index Movement
2) The ECB – June 8
While the ECB is not expected to change policy at the June 8 meeting, the market will nevertheless be sensitive to any changes in the tone of its commentary and indications about the future policy path. Most now expect the economic assessment to be adjusted to “balanced” from “risks to the downside” but Draghi is still likely to emphasize the downward pressure on inflation from still significant economic slack, and maintain the guidance that rates will stay at current or lower levels for an extended period. The question the markets will want answered is whether the ECB will extend its bond buying program beyond the currently scheduled end date of December 17, but the ECB is likely to leave that decision until the autumn. With the upgrade in the economic assessment largely priced in, the EUR will probably only get a very modest boost from the meeting, and one that might not be sustained.
3) The UK Election Build Up – Election on June 8
The early polls for the UK election suggested the Conservatives led by Theresa May would win a landslide victory, and this was seen by many as positive for GBP, as it was seen as improving her negotiating position on Brexit. However, the latest polls have seen the Conservative lead narrow substantially, with concerns about Conservative policy on social care and a lack of positive policy initiatives seeming to drain support. Some polls even suggest that the Conservatives will lose their overall majority in parliament, which was seen as inconceivable when the election was called. While the most likely outcome is still seen to be an increased Conservative majority, the election has become a risk for GBP, as if Theresa May doesn’t get an overall majority it is far from clear that she will be able to form the next government even if the Conservatives are the largest party.
Three-Month GBP/USD Movement
4) Greece (and Italy) – Eurozone Finance Ministers Meeting – June 15
Reports in the German press suggested that Greece was planning to reject new loans from the EU if they did not receive new debt relief, throwing into doubt their ability to meet their scheduled debt repayment in July. However, Greek Finance Minister Euclid Tsakalotos dismissed the report as a distortion and said there would be a solution at the EU finance ministers’ meeting on June 15. Nevertheless, this, along with some increased concerns about a possible early election in Italy spurred by parliament getting closer to agreement on electoral reforms, has re-established some political risk in the Eurozone after the relief following the French election result.
EUR/USD made modest gains through the month on continued uncertainty surrounding the Trump administration and positive Eurozone economic data, which helped create some expectations of an earlier tapering of bond buying from the ECB. However, the 1.13 November high remained intact, and some political concerns about Greece and Italy helped stem EUR gains at the end of the month. The ECB meeting on June 8 and the FOMC meeting on June 13/14 should set the tone for EUR/USD this month. It seems unlikely that we will see a break through the 1.13-1366 area (highs from September and November last year) if, as expected, the ECB retain a bias to ease and the FOMC raise rates in June. The risks should consequently be slightly on the downside, but it is still hard to see major USD gains as long as there is no real news on the Trump/GOP fiscal plans and the Greek debt situation look manageable after the June 15 Eurozone Finance ministers’ meeting, so we would not look for a sustained break below 1.10.
Three-Month USD/CAD Movement
The central view is still that the Conservatives win the UK election with an increased majority, but the increase in the majority now seems unlikely to be large, and may consequently not significantly alter May’s government’s negotiating position coming into Brexit talks with the EU. If the Conservatives don’t get an overall majority GBP is expected to fall sharply, because it would be unclear what sort of government will emerge, with a left leaning coalition becoming a possibility. Even if the Conservatives win with an increased majority, the economic data has been mixed at best and with the uncertainty of the Brexit negotiations approaching the recent GBP/USD foray above 1.30 seems unlikely to be repeated unless there is some much more positive economic news. Data shows short GBP positions in the futures market have now been vastly reduced from the highs, so GBP/USD risks now seem weighted to the downside. Stability near 1.30 is probably the best case scenario which could be likely in the event of the expected Conservative victory with an increased majority, but all other outcomes suggest significant downside, especially if we see higher rates in the US from June 14.
The CAD strengthened through much of the month of May in line with general USD weakness and helped by oil price strength in mid-month. However, CAD strength faded towards the end of the month as the oil price dropped back after OPEC failed to produce any new cuts at the latest meeting. The impact from the lumber tax that sent the CAD lower in April has now been largely reversed, and concerns on the trade front have faded with the Trump tax plan looking both unlikely to be passed soon and unlikely to include a border adjustment tax aspect. But with the Fed looking set to raise rates again this month the bias still looks to be towards the upside for USD/CAD, though strong Canadian Q1 GDP should limit the downside. The June high of 1.38 should therefore be out of reach this month but there is good support in the 1.32-1.34 area.
Three-Month USD/JPY Movement
USD/MXN remained essentially range bound in May with the big support area around 18.00 still out of reach and no real threat on the April high at 19.30 either. US trade policy remains the main driver for USD/MXN, and with this essentially in suspension while US tax reforms are debated, USD/MXN seems likely to remain sidelined. The MXN is less at risk than other currencies from rising US rates, given the already existing yield advantage, so in the absence of other news the 18.30—19.30 range looks likely to hold. Technically, the risks in the short term may be to the upside of this in that gains towards 20 wouldn’t change the long term picture.
Unlike most of the European currencies, the JPY is still some way below its pre-US election levels, as the strength of global equity markets has tended to weigh against it in recent months. However, USD/JPY has been edging lower all year in common with the other majors. Nevertheless, if the Fed raises rates as expected and confidence in the US economy is sustained, it is hard to get too positive about the JPY at these levels, and we would expect to see good support in the 108-110 region.