FX Daily: Conditions Continue to Settle Ahead of US Data

USD: Cautious optimism prevails

A sense of cautious optimism remains in financial markets as various measures of financial stress modestly ease back after last month's US banking crisis. Evidence for those of a bullish mindset is the small drop in emergency dollar demand through the Fed's discount window and the fact that the Federal Home Loan Bank system has had to issue much less debt in support of US regional lenders. It remains a very tricky trading environment, however, given many experienced commentators are refusing to dismiss last month's events as a one-off and instead prefer to see bank failures as a harbinger of forthcoming stress in the global financial system. What will be key to the bullish story is the Fed's ability to cut rates later this year to offset the impending credit crunch. This week's events calendar will shed some light on that. Tomorrow will probably be the most interesting day of the week, where the US March CPI should make the case for a 25bp Fed hike on 3 May (18bp currently priced), while the FOMC minutes will reveal some of the Fed's thinking behind March's 25bp hike in the midst of a banking crisis. Any signs that the Fed is very close to a peak in rates – and that it will have the ability to cut rates if need be –  would be seen as risk-positive and dollar negative. For today, the focus will be on the NFIB small optimism index. Any sharp fall in optimism and especially a further drop in pricing intentions could soften the dollar slightly. DXY can probably drift back to the 102.00 area.(Source; ING)

EUR: 1.10 is holding EUR/USD for now

Recent public holidays may well have played a factor in keeping EUR/USD below 1.10 and the pair only saw a muted reaction to what was a good US March NFP release last Friday. Potentially, EUR/USD could have come a lot lower on this after it firmed up expectations for a 25bp Fed hike on 3 May. Instead, EUR/USD is trading in a narrow range and waiting for its next major input, probably from the western side of the Atlantic. More locally, the Eurozone today sees ECB’s De Guindos Speaks. The week will also see several ECB speakers – especially at the Spring IMF meetings in Washington. Here the market currently prices a 25bp ECB hike in May (I agree) but only 12bp of further tightening in June. I think we could see a further 25bp tightening in June too – leaving the ECB deposit rate at 3.50% – which would then mark the plateau and unchanged rates into the second half of 2024.   EUR/USD can edge back up to the 1.0930/50 area today assuming that equities stay mildly bid and the US NFIB data emerges on the soft side.

GBP: BoE Governor Bailey in Washington this week

Markets currently price a further 25-50bp of Bank of England (BoE) tightening this summer. I think the risk of a pause at the current 4.25% Bank Rate is underpriced. Shedding light on this topic will be UK data and speeches from key BoE officials this week. On the former, Thursday sees the UK February monthly GDP and also the BoE credit conditions survey. Tomorrow sees the BoE Governor speaking on the subject of the 'The shifting risk landscape', where he perhaps can shed some light on the balance between getting inflation under control and the risk of overtightening. EUR/GBP has just about been keeping its head above the 0.8750 support level. I favour a return to the 0.89 area. And my base case is that GBP/USD may struggle to sustain a break above 1.25 this quarter – whilst the Fed is still in the last stages of tightening.

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