The fragile ceasefire in the Iran war is fraying as the US actively tries to break Iran's blockade while maintaining its own.
However, currencies continue to hold their breath and trade in tight ranges. The main exception last week was the yen, which rose sharply after Japanese authorities intervention threats finally materialised. On the downside, Latin American currencies had a difficult week, led by the Colombian peso after the central bank there shocked markets by keeping rates unchanged. The main currencies traded within tight ranges of each other as the spate of major central bank meetings (Federal Reserve, ECB, and the Bank of England) failed to produce significant forward guidance from any of them.
War developments will continue to be paramount for financial markets this week, and currencies will be no exception. As this is written, the ceasefire is being shaken by US attempts to break the Hormuz blockade and Iranian retaliation. However, life goes on beyond the war. In the US, we will get a slate of key labour market indicators for April, culminating in the US payrolls report on Friday. So far, the US economy seems to have largely shrugged off the effects of the war, unlike the Eurozone and the UK. This week's data will issue the final verdict on that narrative.
USD
The US economy continues to almost completely ignore the fallout from the war and higher energy prices. High-frequency labour market indicators are, if anything, suggesting a rebound in job creation. Durable goods orders continue to surprise to the upside, and business investment remains buoyed by massive spending in AI infrastructure.
As we predicted, dissent has become the norm within the Federal Reserve voting members, and a strong hawkish minority has developed that will make it hard for Kevin Warsh to carry out Trump's wishes for lower rates. Chair Powell was somewhat hawkish during what was likely his last presser as chair last week. While we are not in the camp that expects US rate hikes this year, this hawkish twist does at least point to higher rates for longer. In the meantime, we note that the war headlines are having less and less of an impact on the US dollar, and it has barely moved in response to the most recent flare-up of the conflict.
GBP
The Bank of England held rates at 3.75% last week, with chief economist Huw Pill the sole dissenter in favour of a hike. Given the acute uncertainties surrounding the Iran war, we think that the MPC is right to bide its time as it waits to assess the impact of the conflict on second order inflation effects. In an unusual step, the bank opted to present a range of three forecasts dependent on how the conflict unfolds. While this provides markets with little clarity, it does at least avoid falling into the trap of providing premature directional bias without a clear read on how the energy spike will impact the UK economy.
Market consensus suggests two rate increases before the end of 2026, but optionality is not a commitment to hike. By Governor Bailey’s own admission, the bank sees practically no second round inflation effects should the war evolve in line with their expectations, and given weakness in growth and the jobs market, we continue to see limited room for tightening. Meanwhile, the 7th May local elections will be a meaningful political test for the current government. A heavy defeat for Labour could possibly doom Starmer's premiership and facilitate a takeover by the party's far left, a development that would certainly be negative for the pound.
EUR
The ECB kept rates unchanged last week, although it all but pre announced a hike in June, after noting that a rate increase had been discussed at this month’s meeting. Markets are pricing in two full additional hikes by year end. The initial impact of the war on business confidence in the Eurozone has been larger than we expected, so these expectations are likely pricing in a significant easing of energy prices in the medium term. Lagarde also mentioned in her press conference that the bank was not seeing evidence of second round effects just yet.
First quarter GDP growth disappointed expectations last week, suggesting that the common bloc entered into the Iran war already on a fragile footing. We are keeping our bullish forecasts for the common currency, but are paying very close attention to leading economic indicators to see some sort of a bounce there soon. Economic data covering Q2 so far has not been overly encouraging, and another quarter of stagnation appears on the cards.
CNY
USD/CNY has eased from its recent highs, with the yuan also outperforming most of its emerging market peers in recent days.Domestic data, however, has been disappointing. The NBS PMIs slipped in April, with the composite index barely holding above the key 50 level. As elsewhere, the services index bore the brunt of Middle East-related headwinds, slipping back into contraction territory. RatingDog data has fared better so far: the manufacturing PMI rose to 52.2 in April. The remaining services and composite readings will be worth watching on Wednesday, while Friday brings fresh trade figures – April exports are expected to rebound after a subdued March. Attention will then gradually shift to the Trump-Xi summit in Beijing on 14-15 May. While President Trump would likely prefer are solution to the Iran conflict before sitting down with Xi, the ongoing disruption presents its own complications for China as well.
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