FX Daily: Headline Rollercoaster Continues

(MENAFN- ING) USD: No clarity on US-Iran negotiations

US-Iran negotiations are still too fluid for the dollar to break meaningfully in either direction. The latest comments by President Donald Trump poured cold water on yesterday's tentative optimism of an imminent deal, lifting the dollar across the board. This morning, fresh strikes in Iran have been reported. We clearly remain in a headline-to-headline environment for FX.

At the same time, it's worth reiterating how the dollar now enjoys stronger macro support than it did in early May, when markets latched onto an overly optimistic de-escalation narrative. Hot US inflation data from a couple of weeks ago continues to feed through rates and FX, keeping Fed expectations stickier on the hawkish side whenever oil sells off. When Brent was around the current $95-97/bbl in mid-April, market pricing for year-end was 5-10bp of Fed easing. It is now 18bp of tightening.

There is a growing argument that the longer this deal takes to be finalised, the higher the impact on US inflation and global growth, which would provide a strong cushion to the dollar's negative reaction to positive geopolitical news.

On inflation, we have the April PCE data today. We expect core at 0.3% month-on-month, below the 0.5% consensus. That could take a small bit of support off the dollar, but hardly enough to trigger serious dovish repricing. There are plenty of Fed speakers scheduled today, and the tone may remain hawkish-leaning.

April's personal income and spending report is also scheduled for release. Headline spending is expected to be lifted by higher gasoline prices, but otherwise, we are likely to see some weakness in an environment where consumer sentiment is so depressed.

Francesco Pesole

EUR: Brief dip below 1.160

EUR/USD briefly broke below 1.160 this morning on a pessimistic repricing of Middle East sentiment. The 1.1580-90 area is where dip buyers have stepped in over the past 10 days, but that support looks likely to be broken, in our view, should the US-Iran stalemate continue. We still see some risks of a 1.150 test before a rebound, but intraday trading remains highly headline-dependent.

In the eurozone, the only event of note today is the release of the April ECB minutes. These should show the Bank laying the groundwork for a June hike, though the euro reaction may be limited. Markets are already pricing 21bp for June, and meaningful support for the euro would likely require signals of a multi-hike cycle that restores comfort with pricing more than 50bp by year-end. April was probably too early for that message, but June could still deliver a hawkish hike. In our June ECB preview, our macro team highlights how the ECB probably remains concerned about pulling markets away from hawkish pricing too early. We have a few ECB speakers to watch today, including President Christine Lagarde.

Francesco Pesole

GBP: Political risk premium gone

The pound appears to have largely priced out political risk over the past 10 days. We estimate that the EUR/GBP political risk premium (short-term overvaluation) peaked at around 1% on 15 May and has since been unwound back to zero.

This mainly reflects decreased media attention on the topic and the difficulty in pinning down the timing of any leadership challenge. With Prime Minister Keir Starmer pledging to fight on, the most plausible window for a new candidate to emerge would be around September, after a leadership challenge through the summer. Against a backdrop of heavy external headlines, that risk is not especially easy to price into FX at this stage.

The other key factor is that Andy Burnham, the Mayor of Greater Manchester and the candidate seen as the frontrunner by betting markets (and likely the market), has recently adopted a more market-friendly fiscal stance, indicating he would not alter the existing fiscal framework or loosen borrowing limits.

Overall, upside risks for EUR/GBP remain, as some political risk could be repriced. However, absent a particularly hawkish ECB or a dovish Bank of England, the pair may struggle to trade sustainably above 0.870 in the very near term.

Francesco Pesole

CEE: Less hawkish picture undermines koruna strength

Markets in the CEE region have seen some relief in the last two days, along with global markets, with investors backing off from pricing roughly four hikes in Poland and the Czech Republic to roughly two to three hikes over a one-year horizon now. At the same time, Hungary has deepened its pricing of rate cuts after Tuesday's dovish National Bank of Hungary meeting, and at this point, nearly 115bp of rate cuts are expected over the same horizon.

From this perspective, Friday's inflation in Poland will be interesting, where we have seen the biggest jump in CEE so far. May's numbers should move us to 3.7% year-on-year, the highest since June last year and above the National Bank of Poland's tolerance band. For now, our economists do not expect a rate hike this year, but from a CEE perspective, the NBP seems the riskiest at this point. In turn, it seems that further relief in oil prices may not necessarily bring further rate cuts in Poland, given that the real rate should reach neutral levels in May and probably turn negative in June.

The Czech National Bank may be on hold for a longer period due to lower inflation prints in the coming months, and we should see visible inflation divergence between Poland and the Czech Republic emerging in the summer months. Together with an expected ECB rate hike in June, this does not put the koruna in a comfortable position. The interest rate differential should tighten against both the euro and the zloty, leading to underperformance. On Tuesday, EUR/CZK touched its lowest levels at 24.250 since the beginning of the US-Iran conflict.

Frantisek Taborsky

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