Euro Having Harder Time Against Both Dollar and Sterling

The University of Michigan consumer confidence for the month of May unexpectedly set the tone for last week’s trading session WS. The overall indicator fell more than expected, from 63.5 to 57.7, the lowest level since last July. However, markets focused on the prospective inflation expectations component of the report. 1-year inflation expectations fell less than hoped from 4.6% to 4.5%, while long-term (5-10 year) expectations rose from 3% to 3.2% (versus 2.9% consensus), the highest level since March 2011! Similar signs were provided by the NY Fed’s latest survey of consumer expectations (inflation expectations for 3 and 5 years rose by 0.1 percentage points) and in Europe by the ECB survey of consumer expectations.

Median expectations for 1-year and 3-year inflation EMU rose from 4.6% to 5% and from 2.4% to 2.9%, respectively. U.S. Treasuries slipped after the Michigan survey and underperformed German bunds. U.S. yields rose more than 9 basis points in the 2- to 7-year range of the curve, while longer maturities gained 5 to 8 basis points. The 2-year US yield closed just below the psychological 4% mark.

An analysis of the rise in yields shows that it was mainly due to higher U.S. real yields, suggesting that markets probably took the idea of a conditional pause in interest rates, and in particular a rate cut in the second half of 2023, too far. German yields rose 5-6 basis points across the curve last Friday. The relative yield advantage, higher real yields, and a low-risk climate (U.S. equities initially sold off in line with U.S. Treasuries) supported the USD rally last week. EUR/USD closed at 1.0849 (lowest close since March 31) after opening at 1.0916. The trade-weighted dollar climbed to 102.71, taking the first small resistance at 102.40.

Today’s economic calendar includes the EU Commission’s economic forecasts and the US Empire Manufacturing Survey. We don’t expect them to affect the recent market trends. Core bonds are trapped in a sideways movement. Especially the top side of the German Bund futures and the US T-note seems to be very well protected.

In the FX market, the euro is struggling against both the dollar and the pound. Risk sentiment is cloudy, but stronger than feared given ongoing issues like the U.S. debt ceiling and regional banking crisis. Several members of ECB /BoE/Fed have spoken out on policy, and this will be a red line throughout the week. It serves as a placeholder. Key eco points this week include tomorrow’s labour market report from the UK and US retail sales. Strong UK labour market data could further help the pound move away from the EUR/GBP support zone at 0.8719, which was broken last week.