FX Daily: Bearish Yield Curve Steepening Hits Risk Assets

(MENAFN- ING) USD: Pressure builds on the Fed to turn less dovish

The top story in financial markets is the sell-off in the bond market. Losses have been led by the long end of the curve to deliver bearish yield curve steepening. While UK politics may be blamed for a small part of the global bond market sell-off, the bigger story is 10-year US Treasury yields rising to their highest levels since early 2025. This followed a raft of higher-than-expected US inflation data last week, where final demand PPI rose at 6% year-on-year in April – levels we have not seen since early 2023. This kind of inflation is pressure-testing the Federal Reserve and swinging behind the three dissenters at the April FOMC meeting, against the implicit easing bias in the FOMC statement. Looking at the bearish steepening in the bond market today, the narrative is one of the Fed potentially 'falling behind the curve' and the need to at least sound hawkish, even if it does not necessarily hike.

US data this week will not shed too much light on the inflation story. Perhaps Friday's release of University of Michigan inflation expectations (final readings for May) will garner some interest. More interest will be taken in Fed speakers and communication this week. Wednesday's release of the FOMC minutes will shine a light on the hawkish dissent; we're more interested in Fed speakers, though, with Christopher Waller due to speak tomorrow and deliver a speech on the economic outlook on Friday. His most recent speeches seem to have pushed for a prolonged pause in monetary policy, but any shift towards the need for a hike would be dramatic. Were that to be seen, the yield curve would flatten, and the dollar would probably rally further.

High oil prices and now a sell-off at the long end of the bond market are a bearish double whammy for EMFX and for risk assets in general. And the highlight for US equity markets this week will be whether Nvidia's earnings can deliver on Wednesday and keep the increasingly narrow advance of the S&P 500 ongoing. Given that equity markets have been an increasingly important driver of the dollar over recent weeks (risk on, dollar off), the challenges of continued high oil prices and now a bond market sell-off warn of a more difficult equity environment and the dollar staying supported.

DXY faces gap resistance at 99.50 and probably support at 99.00. Later today, we will also see US TIC data for March. So far, there have been no signs of foreigners leaving US securities markets in size. And the recent strength of the dollar is a reminder that last year's loss of safe-haven status after Liberation Day tariffs was more cyclical than structural.

Chris Turner

EUR: Bond sell-off to weigh on growth expectations

Given that the euro is a growth-sensitive currency, the short-term news flow has not been welcome. High energy prices and now higher long-dated interest rates are a headwind to growth. And China's April activity data appeared uniformly bad. Ideally, the European Central Bank would not be hiking into a stagflationary supply shock, but the risk of trying to look through a temporary inflation spike is the loss of control at the long end of the bond market. As such, the ECB will need to continue sounding hawkish, and the 75bp of ECB tightening priced into money market curves this year may endure – that is, unless something breaks.

On the subject of growth, this week's economic calendar sees the flash PMI surveys for May, where the composite reading is expected to have drifted further into contractionary territory. We also have several ECB speakers this week, and perhaps Chief Economist Philip Lane's session in Frankfurt tomorrow might be the first opportunity to hear what the ECB thinks of the recent bond market sell-off.

Expect much focus on the long end of the bond market today, with any further sell-off driving EUR/USD down to 1.1570. The case for restocking on EUR/USD longs right now has yet to be made.

Chris Turner

GBP: Local and global problems

Sterling is being hit by local politics and the global bond market sell-off. As we discussed in an article on Friday, it is hard to see any early resolution to the UK political drama. A by-election will take place in June, where Labour leadership challenger Andy Burnham is far from guaranteed a win. Depending on the outcome of that by-election, we could then see a full leadership election taking place through July and potentially into August. During this period, international investors may want to avoid UK exposure, and at its extreme, another 3-4% in risk premium could be priced into sterling.

At the same time, the Bank of England will be facing similar challenges to its peers in the central bank community – largely centred on what to do about the inflation shock. This week's release of April UK CPI is actually expected to be quite mild because of base effects. But today we hear from rate-setters Megan Greene and Catherine Mann. Let's see if they want to side with Chief Economist Huw Pill, who was the sole voter for a rate hike last month.

EUR/GBP looks biased towards 0.8740, while GBP/USD looks headed towards strong support in the 1.3250/3300 area.

Chris Turner

CEE: The situation is becoming too heavy for the region

Typically, the second half of the month sees the CEE region more muted, and the global story takes the lead. Today in Poland, we will see core inflation for April, which likely rose from 2.7% to 2.9% YoY. On Wednesday, PPI in the Czech Republic and wages in Hungary will be published. On Thursday, wages, industrial production and PPI will follow in Poland. Overall, the data this week has little chance of attracting the market's attention.

On Friday last week, global markets again pulled the CEE region into a risk-off mood, and we saw a quick reaction in rates while FX remained stable. In Poland and the Czech Republic, we again approached 100bp of tightening priced in the 12-month horizon – almost the highest pricing since the beginning of the US-Iran conflict. The market has clearly not forgotten that the conflict is still ongoing, and the Strait of Hormuz is key to seeing any relief here.

However, there aren't too many implications for FX. EUR/PLN maintains a range of 4.230-260, and EUR/CZK remains in the range of 24.300-400. More interesting is the forint, which saw some correction last week and ended above 361 EUR/HUF on Friday. The currency appears to have the largest long positioning in the region by far and therefore also the highest beta against the global story. The lack of progress on the Iran conflict and oil prices, together with a stronger US dollar, is not good news for the forint or the rest of CEE. Therefore, the near-term bias for the region remains bearish over the next few days unless we see some progress on the global side.

Frantisek Taborsky

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