The dollar appears to have found some support on the last day of May. US yields have started to turn higher, which looks both a belated reaction to Friday's strong US data, some very hawkish comments by the Fed's Waller, and oil now breaking well above $120/bl on the news that EU leaders will be pushing ahead with a Russian oil embargo. The reason that the dollar is not firmer probably owes to the fact that bond yields are rising around the world - especially in Europe.
What does this all mean for FX markets? The Rest of the World (particularly Europe) playing catch-up with Fed policy has taken some steam out of the dollar's rally. But the reality is that the EU's Russian oil embargo will weigh on European growth – specifically in terms of trade decline. At the same time, one could argue that the Fed tightening cycle is built on more solid foundations - we expect the dollar later in the summer to push back to the highs seen in early May.
Over the last few sessions, the CAD has made solid progress. The CAD has benefited from the improved risk environment, but the expectation of a hawkish rise (+50bps predicted, with a policy statement implying more 50s are possible) at tomorrow's Bank of Canada policy meeting is also driving gains. The CAD is also benefiting from commodity price growth; energy markets remain tight and supply risks are high, although output is expected to be increased at the OPEC+ meeting on Thursday. Risk reversal pricing has definitely shifted in favor of the CAD, and we expect CAD gains to extend into the 1.25's by the end of Q2. Observe the USD/CAD chart.
Eurozone May CPI inflation should come in close to 8% YoY today. It will be interesting to see what this means for the ECB hikes. Last week’s posts from President Christine Lagarde brought the entire governing board onside with 25bp hikes in July and September. Undoubtedly, this has supported EUR/USD but doubt that EUR/USD can sustain gains over the 1.08 area.
There remains a lot of bearishness surrounding the GBP. The argument goes that hiking rates in a softening economy is a GBP negative. And true, GBP has recently taken on the characteristics of a growth currency, being driven more by equities than rate differentials over recent months. We are slightly negative on the GBP but we think a lot of the weakness is a reflection of broad dollar strength. Look for the GBP/USD to continue trading in a defined range for the short/medium term.
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