The investment climate in the coming weeks will be heavily influenced by both political and economic developments. Key events include central bank meetings and major elections across various regions.

Central Banks’ Actions

European Central Bank (ECB): The ECB is expected to begin an easing cycle, possibly signaling rate cuts or other monetary stimulus measures to support the eurozone economy.

Bank of Canada (BoC): The BoC faces a close call on whether to cut rates in June or wait until July, reflecting ongoing economic uncertainties.

Swiss National Bank (SNB): The SNB may implement its second rate hike of the current cycle, indicating a different approach compared to other central banks.

Bank of England (BoE): The BoE is likely preparing for a potential rate cut in the second half of the year, reflecting ongoing economic challenges.

Federal Reserve (Fed): While earlier predictions of two rate cuts by mid-year have been shelved, the derivatives market still prices in at least one cut by year-end. The Fed’s June 12 meeting will be closely watched for updated projections, potentially showing a median expectation of one cut.

Political Developments

European Parliament Elections: The election outcomes will shape the new European Commission and possibly lead to a new EC President. The rise of polarized voting and a shift to the right are anticipated, with divisions within the right between pro-NATO/pro-EU and populist factions. Strong leadership is essential to address challenges from a potential second Trump term, Russian aggressiveness, and China’s economic pressures.

India: Prime Minister Modi is expected to secure a third term, but a narrower victory could hinder his reform agenda. This may lead to continued foreign investor outflows and pressure on the rupee. However, the inclusion of Indian bonds in JP Morgan’s emerging market indices could mitigate some of these effects.

South Africa: The ANC is likely to lose its majority after 30 years of dominance, leading to potential coalition governments that may not reassure investors. This political instability has already spooked investors, causing the rand to drop and bond yields to rise.

Mexico: With elections on June 2, Claudia Sheinbaum, AMLO’s chosen successor, is expected to win the presidency. Her ability to enact policies will depend on the outcome of congressional elections, with significant issues like border management, Pemex, and green energy development on the agenda.

Economic Outlook

G10 Economies: For the first time since Q2 2023, no G10 economy is in contraction. The US economy continues to expand, driven by a large budget deficit and resilient consumer spending. Both the UK and eurozone have rebounded from contractions in late 2023, while Japan’s economy shows signs of recovery after setbacks from an earthquake and an auto sector scandal.

Australia and New Zealand: Australia’s growth has slowed but remains positive, with expectations of stable, modest quarterly growth. New Zealand’s economy, after a challenging 2023, is projected to return to growth in Q1 2024, with potential rate cuts anticipated later in the year.

Sweden and Norway: Sweden’s economy has surprised on the upside with better-than-expected growth, and another rate cut may be on the horizon. Norway’s economy, after a contraction in mid-2023, shows strong recovery, with no rate cuts expected this year.

These developments underscore the complex interplay of political and economic forces shaping the global investment climate, necessitating careful monitoring by investors.

United States

Dollar Performance in May: A Tale of Two Halves

First Half of May: Downside Correction

  • The dollar experienced a downside correction against most G10 currencies, except for the Japanese yen and the Swiss franc.
  • This correction began in mid-April and extended through mid-May, influenced by weaker-than-expected real sector data.
  • The two-year Treasury yield, which ended April above 5%, fell to around 4.70% by mid-May, reflecting market concerns over the US economy’s strength.

Second Half of May: Dollar Recovery

  • Hawkish comments from the Federal Reserve and the release of the May FOMC minutes helped the dollar recover in the latter half of May.
  • Better-than-expected economic data also supported this recovery, with the two-year Treasury yield climbing back toward 5%.
  • Mid-May futures market expectations for a quarter-point rate cut in September were nearly fully priced in but were downgraded to a 60% likelihood by the end of the month.
  • Expectations for two rate cuts this year were also revised, with the market now pricing in one cut and almost a 50% chance of a second cut.

Economic Data and Market Expectations

  • US Economy Outlook: While data in April suggested a significant slowdown, there is an expectation of sequentially better economic activity in May.
  • CPI Projections:
  • May’s headline CPI is projected to rise by only 0.1%, the smallest monthly increase this year. This mirrors the 0.1% increase from May 2023, likely keeping the year-over-year rate unchanged at 3.4%.
  • The core CPI is expected to rise by 0.3% for the second consecutive month, down from the 0.4% increases seen in Q1 2023. This could result in the year-over-year core rate ticking down to 3.5%.

Treasury and Federal Reserve Actions

  • US Treasury Buyback Program: The Treasury has started a buyback program to enhance market liquidity by purchasing older, less liquid issues and replacing them with larger, new issues.
  • Federal Reserve’s Quantitative Tightening:
  • Starting in June, the Fed will taper its quantitative tightening efforts. It will reduce the roll-off of Treasuries from up to $60 billion per month to $25 billion per month while maintaining the $35 billion per month roll-off of its Agency holdings.
  • Despite some expectations that these actions will support the Treasury market, other factors are likely to play a more significant role.

Treasury Yields and Market Reactions

  • 10-Year Yield Movements: The 10-year Treasury yield rose from around 4.30% in mid-May, peaking above 4.60% before settling near 4.50% by the end of the month. This fluctuation attracted bond buyers at higher yield levels, indicating continued market sensitivity to yield changes.

May was a month of notable shifts for the dollar, heavily influenced by economic data, Federal Reserve signals, and Treasury market dynamics. While the first half of the month saw a correction due to weaker economic indicators, the second half rebounded on hawkish Fed comments and improving data. The outlook for June will be shaped by upcoming economic reports, Fed actions, and market responses to the evolving financial landscape.

Eurozone

Eurozone Economic Recovery and ECB Rate Cuts

Confidence in Recovery: There is growing market confidence in the eurozone’s economic recovery. This optimism is based on recent data suggesting that the region is gradually emerging from economic challenges, prompting expectations for the European Central Bank (ECB) to cut rates.

ECB Rate Cut Expectations:

  • The ECB is widely anticipated to deliver its first rate cut on June 6.
  • Initially, the market expected three rate cuts this year. However, expectations have been scaled back to two cuts, with about a 25% chance of a third cut.
  • Less favorable base effects could push CPI higher, as the total monthly gains through May have resulted in an annualized rate of 4.3%.

Comparative Inflation Rates

  • Eurozone CPI: The eurozone’s CPI has risen by 1.8% through May, translating to an annualized rate of 4.3%.
  • US CPI: In comparison, the US CPI increased by 1.4% through April, equating to an annualized rate of 4.2%.

ECB Economic Forecast and Outlook

  • The ECB will update its economic forecast, potentially reflecting more optimism. In March, the ECB projected eurozone growth at 0.6% for the year.
  • The preliminary May CPI was 2.5%, while the March forecast predicted a 2.3% increase for the year, indicating no significant progress in controlling inflation.

Euro and Treasury Yield Dynamics

  • US-Germany Yield Spread: The premium of the US two-year Treasury yield over its German counterpart fell from above 200 basis points (bp) in late April to below 180 bp by the end of May. This narrowing spread reflects shifting investor expectations and relative economic performance.

Euro Exchange Rate Targets

  • Initial Target Met: Last month, a target range of $1.0870-$1.0900 for the EUR/USD was suggested and subsequently met.
  • Secondary Target: A secondary target in the $1.0935-$1.0950 area has yet to be reached.
  • Support Level: The price action has highlighted the importance of support near $1.0785, serving as a critical level for traders to watch.

The eurozone’s economic recovery and ECB’s upcoming rate cut decision are central to market dynamics. With inflation pressures still present and growth forecasts potentially improving, the ECB’s June 6 meeting will be pivotal. Currency markets will closely monitor these developments, especially the EUR/USD exchange rate, as it navigates between support and resistance levels amidst evolving monetary policy expectations.

United Kingdom

Sterling’s Performance and Market Dynamics

Sterling’s Rally:

  • Sterling appreciated by roughly 2.0% in May, effectively reversing a four-month decline and making it the strongest G10 currency in 2024.
  • The currency is virtually unchanged since the end of last year, reflecting strong performance relative to its peers.

UK Economic Data

Q1 Growth:

  • The UK’s Q1 growth exceeded market expectations, with a quarter-over-quarter increase of 0.6%, the strongest since late 2021.
  • This growth marks a return to activity levels seen before the contraction in the second half of 2023.

Wage Growth and CPI:

  • Following the strong GDP data, wage growth and April CPI figures also came in higher than expected.
  • These developments dampened earlier market speculation about a potential rate cut in June.

Market Expectations and Rate Cuts

Interest Rate Speculation:

  • Early in May, there was a significant probability (just above 60%) of a rate cut in June. However, this probability was nearly dismissed after the release of stronger economic data.
  • By mid-May, the swaps market had fully discounted a rate cut by the end of August, but this has since been reduced to less than a 40% probability.
  • The market now expects the first rate cut to occur in November, fully discounted.

Technical Analysis

Support Levels:

  • Sterling’s rally since the low of the year on April 22 has stretched daily momentum indicators, indicating potential overbought conditions.
  • Key support is identified around $1.2675, providing a critical level for traders to watch.

Political Factors

Upcoming Elections:

  • After suffering significant losses in local elections, Prime Minister Rishi Sunak has called for elections on July 4.
  • Despite the political developments, these elections have not emerged as a significant factor in the foreign exchange market.

Conclusion

Sterling’s strong performance in May, driven by robust economic data and shifting market expectations regarding interest rate cuts, underscores its position as the strongest G10 currency in 2024. While political factors, such as the upcoming elections, have not significantly influenced the forex market, economic indicators and central bank policies remain key drivers. Traders will continue to monitor support levels and economic releases to gauge the currency’s future direction.

China

Tensions Between China and the Rest of the World: Key Considerations

1. Trade Disputes:

  • Global Response to Chinese Exports: Numerous countries, including those in the “Global South,” are implementing measures to shield their economies from an influx of Chinese products such as steel.
  • US Tariffs: The US has announced extensive tariff increases on Chinese products, including electric vehicles (EVs), solar panels, and various other goods.
  • EU Tariffs: The European Union is expected to follow suit with new tariffs after the new European Commission is established.
  • China’s Export Controls: In retaliation, China has imposed new export licensing requirements for dual-use products like plane parts, engines, gas turbines, and bullet-proof materials.
  • Trade Balance: China’s trade balance has remained nearly flat in yuan terms from January to April compared to the previous year, with a slight decrease in dollar terms.

2. Regional Aggressiveness:

  • Military Posturing: China continues to employ aggressive tactics toward neighboring countries, including Taiwan, the Philippines, and Japan.
  • Impact on Alliances: These actions are driving affected countries to seek protective alliances, countering China’s regional influence.

3. Support for Russia:

  • Material Aid to Russia: There is increasing conviction among US and European officials that China is providing material support to Russia in its war against Ukraine.
  • Strained Relations: Despite occasional diplomatic engagements and positive public relations efforts, the relationship between China and Western nations remains tense.
  • Investment Policies: Europe appears more open to Chinese direct investment compared to the US, highlighting a key difference in approach between the two regions.

China’s Domestic Economic Measures

Semiconductor and Property Market Support:

  • New Fund for Semiconductors: China has launched a new fund to bolster its semiconductor industry.
  • Property Market Initiatives: The central government will provide loans to banks, which will then re-lend to local governments to purchase unsold houses and convert them into affordable housing. While seen as a positive step, many observers believe these measures are insufficient to address the broader issues in the property market.

Economic Growth Forecasts:

  • IMF Revision: Following new economic measures and based on Q1 growth figures, the International Monetary Fund (IMF) revised its forecast for Chinese growth to 5% for the year, up 0.4% from the previous estimate.
  • Q1 Growth: Beijing estimates a quarter-over-quarter growth of 1.6% in Q1.
  • Q2 Slowdown: Economic activity appears to have slowed in Q2, with more reforms anticipated during the Third Plenum session in July.

Currency Outlook

Yuan Pressure:

  • Monetary Policy Divergence: The Federal Reserve’s “higher for longer” policy stance contrasts with China’s more accommodative monetary policy, applying downside pressure on the yuan.
  • Yuan Trading Range: There is a risk that the dollar will move back into its previous trading range against the yuan (CNY7.25-CNY7.30).

Tensions between China and other global powers are driven by trade disputes, regional aggressiveness, and suspected support for Russia. These tensions are compounded by divergent economic policies and initiatives within China. While China is making efforts to support key industries and its property market, the broader geopolitical and economic landscape remains challenging. The yuan faces continued pressure amid these dynamics, reflecting the ongoing complexities in global economic and political relations.

Japan

Dollar vs. Yen: May Performance and Key Factors

Dollar’s Monthly Loss:

  • First Monthly Loss: The dollar recorded its first monthly loss of the year against the Japanese yen, though the decline was a modest 0.35%, the smallest among G10 currencies.

Key Events and Market Movements

Intervention by Japanese Officials:

  • Intervention Range: Japanese officials intervened to support the yen in late April and early May, resulting in a significant trading range from just below JPY152 to nearly JPY158. This range was established in the first three trading days of May.
  • Subsequent Dollar Recovery: Following the initial volatility, the dollar gradually climbed higher, despite a mid-month hiccup when the US 10-year Treasury yield dropped over 20 basis points (bp) in three days due to a slight softening of US CPI data.

Yield Movements and Monetary Policy

US and Japanese Yields:

  • US 10-Year Yield: The US 10-year Treasury yield fell sharply in mid-May but later recovered, influencing dollar-yen movements.
  • Japanese 10-Year Yield: The 10-year Japanese Government Bond (JGB) yield rose above 1.0% in late May, marking its first breach of this level since April 2012.

Swaps Market Expectations:

  • BOJ Rate Hikes: The swaps market is pricing in a 10 bp rate hike at the end of the July Bank of Japan (BOJ) meeting and an additional 15 bp increase in Q4.
  • Yield Differential: The US 10-year yield premium over Japan’s fell from around 380 bp in late April, a yearly high, to below 340 bp in mid-May before stabilizing near 350 bp.

Economic Context and Future Outlook

Japanese Economic Recovery:

  • Q1 Contraction: Japan’s economy contracted in Q1, but signs of recovery are emerging.
  • Income Tax Cuts: Upcoming income tax cuts and the phasing out of household energy subsidies are expected to support economic activity.

Technical Analysis and Trading Levels

Dollar-Yen Movements:

  • Late May Levels: The dollar was pushing towards JPY157.70 in late May before becoming more cautious.
  • Support and Resistance: Traders will monitor the dollar-yen movements closely, particularly around key support and resistance levels influenced by yield differentials and central bank actions.

In May, the dollar experienced a minor setback against the yen, driven by Japanese interventions and shifting yield dynamics. As Japan’s economy shows signs of recovery and the BOJ potentially tightens its policy, the dollar-yen pair will remain sensitive to economic data and central bank decisions. Traders should watch for further developments in US and Japanese yields and anticipate possible interventions by Japanese officials to support the yen.

Canada

Canadian Dollar Performance in May

Strong Monthly Gain:

  • The Canadian dollar (CAD) posted a 1% gain in May, marking its best monthly performance of the year.
  • Among the G10 currencies, only the Japanese yen rose less than the CAD.

Key Factors Influencing CAD

Bank of Canada (BoC) and CPI:

  • Inflation: In April, the Bank of Canada’s core measures of CPI fell into the target range, with the rolling three-month annualized rate hitting its lowest point since 2021.
  • Rate Cut Expectations: Throughout May, the swaps market showed increased confidence in a quarter-point rate cut at the BoC’s June 5 meeting. The probability of a rate cut rose to about 80%, up from around 50% at the end of April.

Economic Growth:

  • Q1 Growth: Canada’s economy grew by 1.7% at an annualized rate in Q1 2024, slightly below expectations.
  • Q2 Outlook: The growth rate is expected to slow to below 1% in Q2 2024.

Sensitivity to Broader Market Trends

Risk Environment:

  • The CAD remains sensitive to the broader risk environment, often using the S&P 500 as a proxy for risk sentiment.
  • Correlation with USD: The exchange rate is highly sensitive to the general direction of the US dollar. The rolling 30- and 60-day correlation of changes between the CAD/USD exchange rate and the Dollar Index are above 0.80, the highest level in at least a decade.

Technical Analysis

Exchange Rate Range:

  • In May, the USD/CAD established a trading range between approximately CAD1.36 and CAD1.3750.
  • A break from this range would be significant, indicating potential new trends or volatility in the market.

The Canadian dollar’s strong performance in May reflects improved market confidence in the currency amid shifting expectations for BoC policy and economic conditions. The increased likelihood of a rate cut in June and the CAD’s sensitivity to both broader market risks and USD movements are key factors for traders to watch. The established trading range and its potential breakout will be crucial for future CAD/USD movements.

Australia

Australian Dollar and Economic Overview

Economic Growth:

  • The Australian economy is growing at a steady but modest pace of 0.2%-0.3% quarter-over-quarter.
  • Despite this consistent growth, it lacks significant acceleration that would prompt major policy shifts.

Monetary Policy

Reserve Bank of Australia (RBA) Actions:

  • Interest Rates: The RBA last hiked the cash target rate in November 2023 by 25 basis points to 4.35%.
  • Current Stance: The RBA has maintained this rate since then, despite occasional references in meeting minutes to the possibility of further hikes, which are not taken very seriously by the market.
  • Market Expectations: Since mid-April, the swaps market has not fully priced in a single quarter-point cut for this year. By the end of May, the probability of a rate cut was near 10%.

Inflation and Labor Market

Inflation:

  • CPI Trends: The improvement in Australia’s monthly CPI has stalled, with year-over-year inflation reaching 3.4% in December 2023 and slightly increasing to 3.6% in April 2024.
  • Rate Cut Considerations: For the RBA to consider rate cuts sooner than the market expects, it would likely be due to significant weakness in the labor market rather than a marked decrease in inflation.

Australian Dollar Performance

Exchange Rate Movements:

  • Recovery from Lows: The Australian dollar (AUD) rebounded from its year’s low near $0.6365 in mid-April to almost $0.6715 in May, marking a four-month high.
  • Key Levels: This recovery met key retracement objectives from the decline since the peak of around $0.6870 at the end of 2023.
  • Support Levels: After pulling back, the AUD found support just below $0.6600, indicating a potential stabilization point for the currency.

The Australian dollar’s recent performance and the broader economic outlook suggest a cautious stance from the RBA. While steady economic growth and stalled CPI improvement are notable, the primary trigger for any rate cut would likely be labor market weakness. The AUD’s recovery and subsequent support levels provide key insights for future trading ranges and market expectations.

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