A hawkish failed to lift the yesterday, as the currency market remains heavily focused on risk asset relative performance.
remains in a prime position to benefit from the dollar’s idiosyncratic losses, and today’s widely expected 25bp by the ECB should not prevent another leg higher to 1.15 in EUR/USD, in our view
USD: Powell Rejects Rescuer Role
Fed Chair delivered the clearest message since “liberation day” yesterday, which was unquestionably hawkish. Markets had leaned towards the Trump-backed narrative that the would come to the rescue with rate cuts despite uncertainty.
Powell said he expects higher and a weaker due to tariffs, but that the Fed is primarily focused on the inflation aspect. With Trump having shown greater tolerance to market turmoil than anticipated and Powell now refusing to throw a lifeline, equities remain vulnerable.
In normal market conditions, Powell’s hawkishness would have triggered a positive USD response. But the greenback is still responding to the narrative of relative US assets underperformance and growth concerns, which are arguably being compounded by a hawkish Fed.
Interestingly, front-end USD swap rates didn’t move higher on Powell’s comments, and a cut in June is still more than 60% priced into the OIS curve. This is again a signal of firmly pessimistic growth expectations in the US, which are ultimately seen as leading to Fed easing.
Despite plenty of indications that the dollar is oversold and undervalued, we don’t see a catalyst for a respite today. Should US equities underperform again, should extend its drop below 99.0. Markets will keep a close eye on any hints that jobless claims have risen in the week after “liberation day”. Housing figures are also published today and expected to come in soft.
EUR: Consensus Cut, No Guidance by ECB
We expect a 25bp rate cut by the ECB today. Consensus is unanimous, and markets are fully pricing in the move, so the impact on the euro may prove limited. As discussed in our ECB Cheat Sheet, we don’t expect much in terms of guidance by the ECB, which could echo yesterday’s Bank of Canada communication: openly acknowledge policymakers are as confused as markets on the tariff impact, and they are not able to offer any forward-looking view at this stage.
In the current state of things, the FX market is not looking much at short-term rate differentials. If it did, EUR/USD should be trading well below 1.10. While we cannot exclude the possibility that markets can take the opportunity of an ECB cut to take profit in crowded EUR longs, the news from the US is still hitting the dollar, and the highly liquid euro remains in a prime position to benefit from the rotation.
We retain a tactical target at 1.15 in EUR/USD, with risks of even larger gains. By the end of the quarter, we expect selling pressure on USD to have moderated, and we target 1.14, followed by a dollar recovery in the third quarter.
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