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This week focal point lies in the forthcoming FOMC meeting. Analysts anticipate a more hawkish stance from the Fed regarding interest rate cuts, echoing recent remarks from Fed Chair Powell. Powell hinted at a prolonged timeline, stating, "Recent data have not given us greater confidence and instead indicate that it will likely take longer than expected to regain that confidence" in inflation returning to target levels. This suggests the Fed may hold off on rate cuts until at least two consecutive weaker inflation reports, dispelling notions of a rate cut as early as June. Simultaneously, the Fed is expected to announce plans to halve the pace of reducing the balance of U.S. Treasury securities from $60 billion to $30 billion per month.
This week, keep an eye on the economic indicators. These include the latest U.S. Employment Cost Index (ECI) for Q1, New Zealand's first-quarter labour market report, April's non-farm payrolls report, and ISM manufacturing and services surveys for April. Additionally, watch out for the Eurozone CPI report for April. The U.S. ECI release for Q1 holds particular importance, serving as a litmus test for the Fed to assess whether wage growth is indeed moderating as anticipated. Expect U.S. NFP data and ISM surveys to further solidify indications of robust domestic demand early in the year.
Market sentiment leans heavily toward no change, with 97% of the market anticipating such. Several FOMC participants have expressed no urgency in cutting the FED Funds rate, citing the overall strength of the economy, giving the FOMC time to await more data for greater confidence in inflation returning sustainably to 2%. While some participants still anticipate rate cuts later this year, recent data suggest it may take longer than expected to gain such confidence, possibly necessitating rates to remain unchanged longer than previously thought.
FEDWatch Toll
Credit Agricole forecasts continued downward pressure on EUR/USD due to divergent monetary policies between the European Central Bank (ECB) and the Fed. Despite potential inflationary pressures from a weak euro and high commodity prices, the impact of exchange rate movements on eurozone inflation is deemed limited.
Amidst the monetary policy divergence between the ECB and the Fed, the EUR/USD stands as a pivotal focal point. The currency pair's trajectory hinges significantly on the Fed's stance and the ECB's ability to align with it.
Christine Lagarde, head of the ECB, has raised concerns regarding potential euro depreciation and its repercussions, particularly in the face of soaring commodity prices. Despite her apprehensions, Credit Agricole expresses doubt about market reactions, hinting at possible challenges to Lagarde's resolve.
Recent data shed light on the exchange rate pass-through effect (ERPT), revealing a waning impact of a weaker euro on inflation in the eurozone compared to previous years. For instance, a 10% devaluation of the euro's nominal effective exchange rate (NEER) is now projected to elevate overall CPI by merely 0.2-0.3% over four quarters, a decline from the 0.5% observed previously.
Despite the EUR/USD's weakness, the euro's NEER has shown remarkable resilience, suggesting a containment of direct inflationary impacts.
Looking ahead, the release of the Eurozone's preliminary Harmonized Index of Consumer Prices (HICP) for April is anticipated to underscore ongoing disinflationary trends. This reinforces expectations of an ECB rate cut in June, followed by additional easing measures later in the year.
Based on these factors, EUR/USD is expected to remain a sell on rallies this week, with any upward movements likely to be short-lived. The net speculative position for the EUR has shifted to a sell position of 9,989 contracts, marking the first net sell position since September 2022, after being bought at 12,224 contracts in the previous week.
Insights Inspired by MUFG (FX Daily): Credit to Their Analysis for Shaping Some Aspects of This Text
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