The Dollar Takes a Backseat: Global Factors Shape FX Market in June

FX Daily: June tells us the dollar is not the only game in town

Despite relatively low levels of volatility, June has so far seen some pretty large spot FX moves in both the G10 and emerging market space. These moves seem to reflect a growing conviction of a soft landing in the global economy and a more hawkish view across the G10 central banks outside of the US. Look out for inflation surveys and central bank speakers today.

 

USD: Two factors weighing on the dollar

We have recently been talking about inverted yield curves and late-cycle dollar strength. Looking at USD/JPY, that seems a fair comment given that it is trading not far from its recent highs and the US 2-10 yield curve is inverting even further (now -94bp) on the back of a hawkish Federal Reserve. However, this month in the G10 space, the dollar is only stronger against the yen and is anywhere from 2% (Swiss franc) to 6% (Australian dollar) weaker against the rest of the G10 currencies. This looks like a function of two factors:

1. The first is the increasing hawkishness shown by the rest of the central banks in the G10 space. Inflation forecasts and expected tightening cycles are being revised higher across the board and in some cases more aggressively than in the US. This includes recent surprise hikes from Australia and Canada, a very hawkish ECB meeting yesterday, and very aggressive expectations for Bank of England rate hikes.
2. The second is the bullish global risk environment. Investors are cutting allocations to cash and look to be putting money to work in bonds, equities and emerging markets. Against all the odds the MSCI world equity index is up 14% year-to-date and fund managers are surprisingly suffering from a Fear Of Missing Out (FOMO) on a good rally in benchmark risk assets. Notably, USD/CNH reversed lower yesterday despite the People's Bank of China rate cut – suggesting that investors are instead more interested in the prospect of upcoming Chinese fiscal stimulus.

 

Of course, data remain crucially important and will determine whether central banks need to keep rates tighter for longer or can perhaps start to consider rate cuts – as is the case in some parts of Eastern Europe and potentially Latin America too. But that is ING's central call for the second half of the year – that US disinflation will become more evident through the remainder of this year and that a less hawkish Fed will allow the dollar to sell off.

Back to the short term, the dollar may well stay soft against most currencies except the Japanese yen, with the Bank of Japan remaining resolutely dovish. Here, yen-funded carry trades will remain popular. For today's data, we have the University of Michigan inflation expectations. This occasionally moves markets and any meaningful drop could nudge the dollar lower. Equally, we have three Fed speakers, generally from the hawkish end of the spectrum. 

We think the mood to put money to work probably dominates and barring any big upside surprise in US inflation expectations, DXY can probably edge down to the 102.00 area, if not below.