Currency markets churn as politics takes centre stage

Politics will take centre stage in the next few weeks, with heightened volatility likely in domestic markets and currencies.

 

Highlights:

EUR underperformance continues as investors await French election.

European PMIs weaken, pointing to softer Q2 growth ahead.

US PMI data beats estimates, focus turns to PCE inflation report.

JPY level approaches, as markets brace for FX intervention.

RBA, Norges Bank hold rates, but strike hawkish note.

Focus will largely be on France in the coming days, after the results of the European Parliament elections boosted far right parties and caused Macron to gamble by calling Assembly elections. French polls and political jockeying have joined macroeconomic data and monetary policy as the main focus for traders, even overshadowing this month’s ECB rate cut. Most G10 currencies were choppy last week, but ended up near where they had started, with the notable exception of yen, hammered by a dovish BoJ. On the opposite extreme, the South African rand continues to rally as markets celebrate the agreement between the ANC and the centrist Democratic Alliance.

With little major macroeconomic or monetary policy events aside from PCE inflation in the US on Friday, market focus will remain on politics. Little volatility is expected out of the UK elections on 4th July, since polls unanimously predict a large Labour majority. France will be a different story. The first round of the elections is on 30th June, and while no definitive results are expected until the second round, there will be enough information to drive potentially frantic trading that Sunday night and Monday morning.

USD

Economic news out of the US last week was mixed, with retail sales surprising to the downside but the PMIs of business activity coming out better than expected. The bout of risk aversion in Europe brought about by the uncertainty in the French elections only seemed to help the US dollar, albeit only marginally in another sign that dollar valuation may be getting stretched.

This week should be a quiet one, but the first presidential debate between Biden and Trump on Thursday may be the next political event to shake up markets, as the race to the White House remains too close to call. Beyond politics, the second inflation report of the month, the Personal Consumer Expenditures (PCE) data, will be in focus Friday. Futures markets continue to largely price in two US rate cuts from the Fed this year, one in September and another in December, although an upside surprise here could put this in doubt.

EUR

Political fallout from the European Parliament elections and Macron’s decision to call for early legislative elections continues to weigh on European assets and, seemingly, business optimism. The June Eurozone PMIs came out considerably weaker than expected, and the gap between the US and European economies seems to be growing again.

The euro put in a decent performance, all things considered, falling less than 1% against the dollar. We view this as a sign that the current cheap levels in the common currency already price in a lot of downsides, and it may be difficult for the euro to fall much further from here, baring a shock majority for either the right or left wing parties in France on Sunday. While much of the talk has centred around the possibility of a strong showing for Marine Le Pen’s Nation Rally, we think that a majority victory for the far-left Popular Front poses a far bigger risk to European assets.

GBP

The Bank of England kept policy unchanged as expected last Thursday, with the vote split 7-2, as it was at the previous meeting. Policymakers said that they would need to see more news on inflation before cuts could commence, but it also hinted that it could begin lowering rates in August, as some members saw this month’s rate decision as ‘finely balanced’. Better news on the inflation front, a tentative loosening of the labour market and last week’s weaker than expected PMI surveys all point in the same direction. Markets are pricing even odds of such a cut, but we think that absent a serious inflation surprise, the BoE will follow on the steps of the ECB and start cutting rates at the next meeting.

The prospects of a Labour victory next week remain a positive for GBP, as markets will continue to price in closer ties with the EU. This could be enough to negate the downside stemming from the possibility of a summer BoE rate cut.