GBP

Sterling soared higher against the dollar last week in line with every worldwide currency, though it lagged a bit against the euro, and most G10 currencies for that matter. This can perhaps partly be explained by valuation, as sterling was already trading at very lofty levels given the extent of its year-to-date rally. High interest rates and better than expected economic data continue to support the pound, notably ongoing signs of elevated wage pressure, which remains around record highs.

The May GDP print also outperformed expectations (-0.1% vs. -0.3% consensus), despite the negative impact of the additional bank holiday due to the King’s coronation. Mercifully, worker strikes are beginning to become slightly less onerous, as the number of days lost in May fell to its lowest level since mid-2022. The key number for sterling will, however, be the June inflation report out on Wednesday. Markets are expecting a drop in the headline number and a stable core index, which we think should be consistent with another 50bp hike at the August Bank of England meeting. This is not yet fully priced in, so we see room for continued sterling strength.

EUR

The disinflationary news in the US sent the euro straight higher, and the common currency broke cleanly out of the range that had held for most of 2023, soaring above the $1.12 level to its strongest positions since February 2022. The move is understandable given expectations for a narrowing in US-Euro Area rate differentials and in line with our forecasts, but gloom around European growth may provide some headwinds in the short-term. The Euro Area economy is currently in the midst of a recession, and recent soft economic indicator data suggests that another quarterly contraction in GDP could be on the way in the third quarter.

Until the state of the Eurozone economy is clarified and the pessimistic PMI numbers are confirmed or refuted by hard economic data, the euro may have a difficult time rallying any more in the near-term, particularly given stretched market positioning. Major data out of the common bloc is scarce this week, aside from revised inflation data on Wednesday.

USD

The June inflation report confirmed that US inflation is slowly but clearly headed the right direction. Inflation undershot expectations in both the headline (3.0%) and core indices (4.8%), and the three-month running average in the latter is now down to 4% on an annualised basis – this metric has only been lower on one occasion since the start of the current inflationary episode (September 2021).

The Fed is still likely to hike rates again in July, having effectively precommitted to do so. However, any further hikes would need significant upside surprises in inflation data and economic activity, which we see as unlikely. Markets appear to be in agreement, with futures now assigning only around a one-in-four chance of a second hike before November. With the Fed hiking cycle seemingly coming to a close, the backdrop turns more favourable for our core view that emerging market currencies have further to appreciate.

JPY

Last week’s broad dollar sell-off brought some much needed relief for the yen, which had been flirting with the 145 level for almost all of early-July. At the time of writing, the USD/JPY pair is trading back below the 140 mark and around its lowest level in a couple of months, which should ease speculation in favour of direct FX intervention. Whether the yen can hold onto its gains will likely depend largely on communications from the Bank of Japan, which will announce its latest policy decision on the Friday after next (28/07). As mentioned last week, we continue to contest that a tweak to the yield curve control (YCC) policy isn’t too far away, which could open the door to a first BoJ rate hike by year-end.

This Friday’s national inflation data for June will be highly important for the market’s Bank of Japan rate expectations. Any upside surprises here could support the yen, particularly as markets are now barely pricing in any policy tightening from the BoJ during the remainder of the year (only 2bps by the December meeting).

CNY

The yuan managed to end last week more than 1% higher against the broadly weaker US dollar, although it was one of the worst-performing currencies worldwide, with the trade-weighted CFETS RMB index falling to its lowest level since January 2021. Economic data is turning more nuanced, albeit on the whole, it still points to weakness of the recovery and calls for more stimulus appear to be getting louder. Second-quarter GDP growth disappointed today, showing an expansion of 6.3% YoY – the figure itself may seem high, but it was boosted by a low base effect from a year ago.

Nearly all of the key economic readings are already out, therefore attention in the coming days will turn to news from elsewhere. While we cannot entirely exclude more monetary easing at some point, LPR rates are universally expected to remain unchanged on Thursday. Earlier today, the PBoC kept the MLF rate stable, and in addition to rolling over maturing loans, injected only an additional 3bn yuan into the system through the facility. The bank possibly does not want to overdo stimulus, particularly as June’s credit data was much stronger than expected.