GBP

A quiet week in the UK saw sterling trade in rather tight ranges with both the euro and US dollar. The pound continues to benefit from the Bank of England’s hawkish turn, most notably the surprise 50bp interest rate hike at its June meeting. Market expectations of the terminal rate in the UK continues to approach 6.5%, the highest in the G10 by some margin, and there are few signs as yet that the UK economy cannot bear it. BoE governor Bailey gave absolutely nothing away during his Sintra appearance, neither pushing back against market pricing, nor condoning further aggressive tightening.

We are in the midst of a rather quiet period of UK economic data, with no more than revised first quarter GDP data out last week, and the updated June PMIs this week. In the absence of any bad news, investors will likely continue to take an optimistic view on the UK economy, while betting on continued hawkishness from the BoE. This is a bullish combination for sterling.

EUR

If the speeches by European Central Bank officials last week are anything to go by, the Governing Council remains squarely focused on bringing down inflation, and the end of the hiking cycle is not in sight just yet. Speaking in Sintra last week, president Lagarde again all but confirmed that another 25bp rate increase is on the way later this month – indeed this is now more than fully priced in by swap markets. However, weak news from China and general gloom from the manufacturing sector are keeping the euro from benefitting too much from the ECB’s hawkishness. 

Even after the recent increase in expectations for terminal rates, we still think there is plenty of room for additional hikes, and do not think that the ECB rate can peak below 4%. Last week’s flash inflation report offered some support for our view. Core inflation, which the ECB is increasingly highlighting in its communications, slightly missed expectations, although actually rebounded a bit relative to the previous month and shows every sign of stabilising at an unacceptably high level above 5%.

USD

Economic data in the US has been surprising to the upside lately. Last week we saw strong durable goods and new home sales reports. Weekly jobless claims remain at low levels and GDP numbers for the first quarter were revised up, to 2% annualised, on stronger consumer spending and exports. The Fed’s preferred measure of inflation, the PCE index, was a miss, although the core PCE inflation measure remained stubbornly high at 4.6% in May. 

Expectations for further Federal Reserve rate hikes continue to be ratcheted up, but this has so far been of limited help for the US dollar, partly because expectations for hikes are rising across the G10. A 25bp hike is now almost fully priced in for the July meeting, though futures currently only see around a one-in-three chance of another beyond then, so there may be room for dollar upside should the Fed continue to strike a hawkish note in the coming weeks. This week, we expect the run of good news to continue with a strong labour market report. However, the impact in the dollar will be limited, unless we see signs of a reacceleration in wages.

JPY

The yen remains one of the least favoured major currencies among investors, as markets continue to take a dim view of the Bank of Japan’s ultra-dovish monetary policy stance. The BoJ has continued to appear in little rush to signal that tighter policy is on the way, and markets now only see a one-in-four chance of a 10bp hike by September. Officials have hinted that they may intervene in the FX market in an attempt to prop up the yen, though this has been insufficient in order to support the currency thus far, which continues to make a march towards the 145 level on the dollar.

We suspect that authorities will draw a line in the sand at 150 JPY to the USD, and will delve into their ample foreign currency holdings in order to prevent a move above this level, just as they did in October. We still think that this is unlikely to provide anything more than temporary respite for the yen, as we would probably need to see signs of a hawkish pivot from the BoJ in order to turn the tide for the currency. We contest that an adjustment to the YCC could be on the way at either of the next couple of meetings, which may pave the way for a long-awaited rate hike before year-end, although clearly the possibility of this has lessened in recent weeks.

CNY

The yuan had a dismal week, weakening by 1% against the US dollar and underperforming the vast majority of its emerging market counterparts. USD/CNY edged closer to the psychological 7.30 rate, just shy of its November high (≈7.33) and its highest level since 2007. It appears that the pace of the yuan’s recent depreciation has not gone unnoticed by authorities. Sources suggest that state-owned banks have been selling foreign currency to support the weakening yuan. Moreover, the PBoC has set stronger fixings in recent days and, on Friday, the bank reiterated its pledge to keep the yuan basically stable following its Q2 monetary policy meeting. 

 
Looking ahead, attention will be on signals from authorities and economic data, particularly the remaining services PMI print from Caixin, out on Wednesday. NBS data released last week did not rock the boat, albeit it showed yet another decline in the composite index, dragged lower by weaker expansion in the non-manufacturing sector. The Caixin manufacturing PMI data released today provided a minor, positive surprise and small expansion. Any headlines from the US treasury secretary Yellen’s trip to China (06/07-09/07) will also be closely watched.