Economic Data and Political Uncertainty Shape Currency Trends.

• GBP/USD Gains: The GBP/USD pair strengthens to around 1.2655 as the US Dollar weakens due to the lowest annual rate of the US PCE Price Index in over three years.
• Fed Rate Cut Speculation: Cooling US core PCE figures prompt speculation of a Federal Reserve rate cut, with May’s core PCE rising 2.6% from 2.8% in April.
• Key Data Releases: Traders anticipate this week’s ISM survey results, FOMC minutes, JOLTS job openings, and June’s jobs report for further market direction.
• Political Developments: US political dynamics, including President Biden’s potential withdrawal from the race, could impact the USD, especially if California Governor Gavin Newsom becomes the Democratic candidate.
• EUR and GBP Factors: EUR/USD benefits from reduced French political risk, while the UK election week is not expected to significantly impact GBP markets despite a likely Labour landslide win.

USD: The GBP/USD pair trades on a stronger note around 1.2655 during the early Asian session on Monday. The US Dollar (USD) edges lower as the US Personal Consumption Expenditures (PCE) Price Index for May eased to its lowest annual rate in more than three years, which provides some support to the major pair. Traders await the US June ISM Purchasing Managers Index (PMI) for fresh impetus, which is due on Monday.  The US core PCE, the Federal Reserve’s (Fed) preferred inflation measure, continued to cool in May, prompting speculation that the Fed will cut the interest rate this year. The core PCE figure climbed 2.6% from 2.8% in April, matching the forecast. The headline PCE increased 2.6% YoY in May from 2.7% prior, in line with the estimation. The Fed officials emphasized in recent weeks that they will cut interest rates when they gain confidence that inflation has decelerated to the 2% target. New York Fed President John Williams said that inflation is still at problematic levels and the US central bank will act to lower it. Fed Governor Michelle Bowman noted that while current Fed policies should be enough to bring inflation back to target, adding that the central bank shouldn’t be unwilling to weigh further rate cuts if inflation data remains stubborn.

The US macro story is increasingly pointing to a softening in the dollar. The three main data releases this week are the ISM survey results (manufacturing today, services on Wednesday), the FOMC minutes (Wednesday), JOLTS job openings for May (Thursday) and June’s jobs report (Friday).

The ISM PMIs are expected to show a marginal improvement in manufacturing – while remaining in contraction – and a softer services figure, while still in expansion. All in all, there is a chance the surveys won’t be adding much more to the activity narrative. Instead, jobs figures should set the undertone for markets outside of the impact of EU political developments until June CPI figures are released on 11 July. Interestingly, consensus is for another drop in JOLTS job openings after the surprise April contraction which hit the dollar. When it comes to the payroll print, jobless claims data and weak business hiring surveys suggest the jobs market is softening, and we don’t expect another strong read for June. Consensus is currently at 190k, and there are chances of an even softer print.

Ultimately, we expect jobs figures to support the case for a rate cut in September. As discussed by James Knightley here, the 0.08% month-on-month (rounded to 0.1%) core PCE figure for May and the cooldown in consumer spending are all pointing in that same direction. We don’t think the Federal Reserve will want to drive the economy into an unnecessary downturn, and September remains the most likely start date for an easing cycle.

We’ll hear what Fed Chair Jerome Powell will have to say about this at Sintra’s European Central Bank forum tomorrow. He has generally shown a sanguine tendency when it comes to disinflation, and he may ultimately neutralise the impact of FOMC minutes on Wednesday, which could be more hawkish given the June Dot Plot.

Finally, a lot of focus will remain on US political developments as President Joe Biden faces mounting pressure to step down from the race. Should this happen, the Democratic party committee would decide a new nominee. The favourite would automatically be VP Kamala Harris – who has even lower approval ratings than Biden. California Governor Gavin Newsom is seen as a more likely successor at this stage. That’s unlikely to be a smooth process, but with consensus having shifted more in favour of a USD-positive Trump victory after last week’s debate, Biden dropping out could be a USD-positive development, especially if Newsom becomes the candidate.

We aren’t convinced the peak of French political impact on the FX market is past us, so while we see US macroeconomic data as mostly USD-negative in the coming weeks, we doubt this will translate into a clear-cut dollar decline due to EU political risk. DXY may break below 105.0 on softening US jobs figure and a dovish Powell this week, but may then encounter increasing support below that level.

EUR: It appears that EUR/USD is getting rid of some political risk premium this morning after preliminary results from the first round of French parliamentary elections came in close to pre-vote polls. Marine Le Pen’s National Rally is projected at 34%, followed by the leftist New Popular Front at 29% and President Emmanuel Macron’s centrist alliance at 22%. The positive reaction in the euro is, in our view, primarily due to some market relief for the New Popular Front not gaining more than expected.

Still, first round results are not offering much certainty about the composition of the parliament, and the second round scheduled for the next weekend is in fact the big risk event. We’ll be monitoring closely the performance of OAT versus the bund today. There is a chance of some tightening in the spread which can help the euro, but our rates team continues to view structurally wider spreads beyond the short term and we doubt the euro will be able to entirely erase political risk premium this summer.

On the data side, the eurozone calendar’s main highlight is the flash CPI estimates for June, released tomorrow. German numbers are due this morning and are expected to show a slowdown from May’s 2.4%. Inflation did come down as expected in France and Spain’s CPI estimates released on Friday.

The ECB’s forum in Sintra runs from today until Wednesday and will offer plenty of discussion on policy and inflation. ECB President Christine Lagarde delivers prepared remarks today and on Wednesday, and participates in a panel with Powell tomorrow. Among other speakers in Sintra, Isabel Schnabel and Philip Lane stand out. On Thursday, June’s ECB minutes are released.

Markets should end this week with a slightly clearer picture on the ECB path ahead given CPI data and ECB-speak, but the political factor should remain the main driver for the common currency until next week’s second round results in France are out. We think soft US data can help a move above 1.0800, but a return to 1.0900 is a relatively long shot considering risks of rewidening EGB spreads.

GBP: It is election week in the UK, and the BBC poll tracker puts Labour at 40%, Conservatives at 20%, Reform UK at 16% and Liberal Democrats at 11%. There has, indeed, been very little doubt about a Labour landslide win, so the election should not be a huge event for markets. We suspect that a stronger than expected result by populist/hard-Brexiteer Reform UK is the most tangible risk for some slight adverse reacting in GBP assets.

As widely discussed recently, the chances of the election result deviating the Bank of England policy path are very low, and the pound should continue to rely on external drivers (both in EU politics and US macro) and key domestic data releases. June CPI and jobs report aren’t published before 17-18 July, so even if we see expect a cut in August (market pricing 15bp) to hit the pound, the case for a materially stronger EUR/GBP within the next couple of weeks is not very compelling.