Market Analysis: Euro Weakness Anticipated as ECB Rate Cut Looms
The previous five-weeks and an outlook for the upcoming five days
Tuesday, 04 June, Week 23: This report provides a comprehensive analysis of the forex market, focusing on the DXY and key currency pairs EUR/USD, GBP/USD, and USD/JPY. It examines the performance of these currency pairs over the past five weeks and provides a five-day forecast based on current market fundamentals and upcoming risk events. The report also delves into significant geopolitical and market themes influencing the forex market, including the ongoing Israel-Hamas war, the upcoming US presidential election, the global economic slowdown, and monetary policy divergence.
DXY
The DXY, which measures the US dollar against a basket of major currencies, has been on an upward trend over the past five weeks, reflecting the US dollar's broad strength. The index has risen from a low of 104.23 on May 15 to 105.13 on May 29, before retreating slightly to 104.75 on June 3. This strength is attributed to several factors, including the Federal Reserve's hawkish stance on monetary policy, safe-haven demand amid geopolitical uncertainty, and the relative resilience of the US economy compared to other major economies.
Over the next five days, the DXY is expected to remain supported, with the potential for further gains if the ECB cuts interest rates as widely anticipated. The US dollar is likely to benefit from the divergence in monetary policy between the Fed and the ECB, as well as from safe-haven demand amid ongoing geopolitical risks. However, any upside surprises in Eurozone economic data or a less dovish than expected ECB could limit the DXY's gains.
Upcoming Risk Events:
June 05 (Wednesday): US ADP Employment Change (May)
June 06 (Thursday): ECB Interest Rate Decision
June 07 (Friday): US Non-Farm Payrolls (May)
EUR/USD
EUR/USD has been on a downtrend over the past five weeks, falling from a high of 1.096 on May 5 to a low of 1.063 on May 15. The pair has since recovered somewhat, but it remains below the 1.08 level. The euro's weakness is primarily attributed to expectations for an ECB rate cut, which would widen the interest rate differential between the Eurozone and the US. Additionally, the ongoing war in Ukraine and concerns about the Eurozone's economic outlook have weighed on the euro.
Over the next five days, EUR/USD is forecast to weaken further, potentially testing the 1.06 level. The ECB's widely anticipated rate cut is likely to weigh on the euro, particularly if the ECB signals that further rate cuts are possible. Additionally, the US dollar is likely to remain supported by safe-haven demand and the Fed's hawkish stance. Trading Economics forecasts EUR/USD to trade at 1.08 by the end of the quarter, suggesting a potential rebound later in the period. However, the short-term outlook remains bearish.
Upcoming Risk Events:
June 06 (Thursday): ECB Interest Rate Decision
June 07 (Friday): US Non-Farm Payrolls (May)
GBP/USD
GBP/USD has been trading sideways over the past five weeks, fluctuating between 1.245 and 1.281. The pair has been supported by positive UK economic data, including stronger-than-expected GDP growth in the first quarter. However, political uncertainty ahead of the July 4 general election and expectations for further Bank of England rate hikes have limited the pound's gains.
Over the next five days, GBP/USD is forecast to remain range-bound, with the potential for some volatility around key economic data releases and the ECB's interest rate decision. The outcome of the general election and the direction of monetary policy remain uncertain, making it difficult to predict a clear direction for the pair. Trading Economics forecasts GBP/USD to trade at 1.27 by the end of the quarter, suggesting a potential for a modest appreciation. However, the short-term outlook remains neutral.
Upcoming Risk Events:
June 04 (Tuesday): UK GDP Growth Rate (Q1, second estimate)
June 06 (Thursday): ECB Interest Rate Decision
June 07 (Friday): US Non-Farm Payrolls (May)
USD/JPY
USD/JPY has been on an uptrend over the past five weeks, rising from a low of 136.7 on May 15 to a high of 139.4 on May 24. The pair has since pulled back somewhat, but it remains above the 138 level. The yen's weakness is primarily attributed to the divergence in monetary policy between the Fed and the Bank of Japan, with the Fed expected to hold rates steady while the BOJ maintains its ultra-loose policy. Additionally, safe-haven demand for the US dollar amid geopolitical uncertainty has weighed on the yen.
Over the next five days, USD/JPY is forecast to remain supported, with the potential for further gains if the divergence in monetary policy between the Fed and the BOJ persists. The US dollar is likely to benefit from safe-haven demand and the Fed's hawkish stance, while the yen is likely to remain under pressure. Trading Economics forecasts USD/JPY to trade at 138.00 by the end of the quarter, suggesting a potential for a modest appreciation. However, the short-term outlook remains bullish.
Upcoming Risk Events:
June 05 (Wednesday): US ADP Employment Change (May)
June 07 (Friday): US Non-Farm Payrolls (May)
Geopolitics and Market Themes
Israel-Hamas War and Regional Tensions
Synopsis: The ongoing war between Israel and Hamas has entered its fourth week, with Israel continuing its military offensive in Gaza. Regional tensions remain high, with the potential for the conflict to escalate further.
Key Developments:
Israel has reoccupied the southern Gazan city of Rafah, encountering heavy resistance from Hamas.
The United States is attempting to broker a ceasefire agreement, but negotiations have stalled.
Regional actors, including Iran and Hezbollah, have condemned Israel's actions and threatened retaliation.
Assessment: The conflict has contributed to risk aversion in global markets, supporting safe-haven assets like the US dollar and Japanese yen. Uncertainty surrounding the conflict's duration and potential for wider regional involvement could continue to weigh on risk sentiment. Forex traders should monitor developments closely, as any escalation could trigger sharp moves in currency markets. Continued conflict could lead to further strengthening of the US dollar and Japanese yen, while riskier currencies could weaken.
Quote: "Israeli officials told me the Israeli hostage deal proposal President Biden presented in his speech exhausted Israel's manoeuvring space. There will not be a better one. If Hamas rejects it, the conflict will likely escalate." - Barak Ravid, Axios
U.S. Presidential Election
Synopsis: The 2024 US presidential election campaign is intensifying, with former President Donald Trump facing multiple criminal trials. The outcome of the election could have significant implications for US domestic and foreign policy, including trade relations and geopolitical alliances.
Key Developments:
The Republican National Convention is scheduled for July 15-18 in Milwaukee, Wisconsin.
The Democratic National Convention is scheduled for August 19-22 in Chicago, Illinois.
Assessment: Uncertainty surrounding the election outcome and potential policy shifts under a new administration could contribute to market volatility, particularly in the US dollar. A second Trump term could lead to renewed trade tensions with China and a more unpredictable foreign policy approach, potentially impacting risk sentiment and currency valuations. Increased uncertainty in the lead-up to the election could lead to volatility in the US dollar, with safe-haven flows potentially supporting the currency.
Quote: "I’m OK with it," Donald Trump said on "Fox & Friends" as he discussed the prospect of prison time for his hush money conviction. He also suggested there could be a "breaking point" if he were to be jailed. "I’m not sure the public would stand for it," - Donald Trump, Former US President
Global Economic Slowdown
Synopsis: Concerns about a global economic slowdown persist, with growth slowing in major economies like the US, Eurozone, and China. High inflation, rising interest rates, and geopolitical uncertainty are weighing on economic activity.
Key Developments:
The US economy expanded by an annualised 1.3% in Q1 2024, below expectations.
The Eurozone economy grew by 0.3% in Q1 2024, recovering from a contraction in the previous two quarters.
China's economic recovery has been slower than anticipated, with weak consumer spending and ongoing property market woes.
Assessment: Fears of a recession are contributing to risk aversion in financial markets, supporting safe-haven assets like the US dollar and Japanese yen, and pressuring riskier assets like stocks and commodities. Forex traders should closely monitor economic data releases for signs of further slowing, which could lead to increased volatility and shifts in currency valuations. A continued slowdown in global growth could lead to further strengthening of the US dollar and Japanese yen, while riskier currencies and commodity-linked currencies could weaken.
Quote: "Slower labour market momentum will continue to limit income growth and push more families to exercise spending restraint amid reduced savings buffers and higher debt burdens,”Factoring increased price sensitivity, household spending momentum will gradually cool.” - Gregory Daco, EY Chief Economist
Monetary Policy Divergence
Synopsis: Central banks around the world are at different stages in their monetary policy cycles, with some continuing to raise interest rates while others are considering cuts. This divergence in policy is creating volatility in currency markets.
Key Developments:
The Federal Reserve kept interest rates unchanged at 5.25%-5.50% in May.
The ECB is expected to cut interest rates by 0.25% on June 6.
The Bank of England kept interest rates at 5.25% in May, but two committee members voted for a cut.
Assessment: The US dollar has strengthened against most major currencies as the Federal Reserve maintains a hawkish stance. The euro is weakening as the ECB prepares to cut interest rates. The Japanese yen remains under pressure due to the Bank of Japan's ultra-loose monetary policy. Forex traders should pay close attention to central bank communications and interest rate differentials when making trading decisions. The divergence in monetary policy is likely to continue to drive currency market volatility in the coming weeks. The US dollar is likely to remain strong against currencies with dovish central banks, such as the euro, Japanese yen, and Canadian dollar.
Quote: "Policymakers acknowledged that while inflation has moderated over the past year, it remains elevated, and there has been a notable lack of further progress towards achieving the central bank's goal in recent months. Still, Chair Powell stated that he does not foresee a hike as likely and believes that the current policy is sufficiently restrictive to achieve the 2% inflation target." - Federal Reserve, May Meeting Minutes
Conclusion
The forex market is likely to remain volatile in the coming week, driven by the ECB's interest rate decision, key US economic data releases, and ongoing geopolitical uncertainty. The US dollar is expected to remain supported, particularly against the euro and Japanese yen, due to the divergence in monetary policy and safe-haven demand. The British pound is likely to remain range-bound, with the outcome of the general election and the direction of monetary policy remaining uncertain. Forex traders should closely monitor economic data releases, central bank communications, and geopolitical developments when making trading decisions.
References
Axios: https://www.axios.com/
Bank of England: https://www.bankofengland.co.uk/
Bloomberg: https://www.bloomberg.com/
European Central Bank: https://www.ecb.europa.eu/
Federal Reserve: https://www.federalreserve.gov/
Office for National Statistics: https://www.ons.gov.uk/
Trading Economics: https://tradingeconomics.com/
U.S. Bureau of Economic Analysis: https://www.bea.gov/
U.S. Bureau of Labor Statistics: https://www.bls.gov/