Written by the Market Insights Team
Inflation chills, dollar spills
George Vessey – Lead FX & Macro Strategist
The latest Consumer Price Index (CPI) data showed headline and core inflation rising 0.1% m/m in May, down from April’s prints and below forecasts. This means, on a year-over-year basis, headline CPI ticked up to 2.4% (vs. 2.3% prior), while core remained steady at 2.8%. It marks the fourth straight month of weaker-than-expected core inflation, reinforcing the disinflation trend. Markets responded by pricing in more Federal Reserve (Fed) easing this year. Treasury yields declined and the US dollar index dropped by the most in a week.
The string of below-forecast inflation prints suggest consumers have yet to fully experience the effects of President Trump’s tariffs, likely due to temporary tariff pauses, companies absorbing costs, or pre-emptive inventory stockpiling. However, domestic service prices, including housing, appear restrained too, hinting at consumer caution and income insecurity – offsetting any inflationary pass-through from tariffs.
The broader impact of the trade war remains disinflationary at this stage, which, all else being equal, is supportive for financial assets. However, anecdotal signs that corporations are preparing price hikes could keep the Fed wary, hence the rather muted reaction in equities.
Investors are also likely focusing on tariffs’ reflationary effects and long-end supply dynamics, which point to continued steepening of the yield curve. This is a dynamic we’ve referenced frequently in relation to driving USD weakness too.
New tariff threats drive haven demand
George Vessey – Lead FX & Macro Strategist
The other important news is that President Trump said a trade deal with China was done. However, markets remained cautious as the agreement lacked concrete details and still requires final approval from US and China presidents. Then, overnight, Trump said he plans to send letters to trading partners within the next one to two weeks, outlining unilateral tariff rates ahead of a July 9 deadline. Risk sentiment soured and trade uncertainty ramped up once again.
The dollar weakened against most G10 currencies, while gold, the Swiss franc, and the yen gained on haven demand. The US dollar remains a key barometer of trade sentiment, and its failure to extend higher in the wake of the so-called deal with China was telling. Now, it’s under increased selling pressure once more, with the dollar index looking poised to hit a fresh 3-year low.
As the US engages with India and Japan to negotiate lower tariffs, some view Trump’s latest remarks as a tactic to increase pressure in trade discussions. Scepticism also remains about whether he will follow through on his pledge, given his track record of setting tight deadlines that often shift or go unfulfilled.
As ever, this persistent uncertainty continues to weigh on businesses, consumers, and investors, making it difficult to plan for potential policy shifts. Markets remain on edge, awaiting clearer signals on whether tariff adjustments will materialize or simply remain a negotiating tool.
Euro’s tug-of-war: trapped in uncertainty
Antonio Ruggiero – FX & Macro Strategist
The euro climbed back above $1.15 versus the USD following a softer-than-expected US inflation report and Trump’s tough talk on tariffs again. The rally was underpinned first by heightened Fed rate cut expectations, which helped narrow the yield differential that still favours the dollar, offering some support to the euro. Still, the move stood out, as rate differentials have recently had a diminished role in driving price action, with broader US sentiment acting as the dominant force instead. Then came Trump’s latest tariff threat, which sent traders flocking to safe haven alternatives to the dollar.
EUR/USD has managed to break out of its well-worn and frustrating range between $1.1380 and $1.1445, although the move may prove short-lived. The common currency continues to struggle in mounting a sustained push toward April’s highs, with resilience in the US economic outlook proving a key headwind.
Underneath it all, volatility remains a crucial driver of short-term direction for the euro. Since the start of Trump’s presidency, the euro has been a primary beneficiary of heightened market uncertainty: Investors have piled into long euro positions, using it as a dollar alternative to hedge against US-driven volatility.
Over the past two months, however, EUR/USD risk reversals in favor of euro calls have softened across the volatility curve. While trade developments have curbed euro bullishness, other factors—some even euro-driven—may have quietly contributed to less aggressive positioning: Lagarde’s hawkish stance was undeniably supportive for the euro, but ultimately removed the very fuel that had been driving it higher for months—volatility. Markets now have clarity on the ECB’s policy path, with no rate cuts until after summer and only a 47.7% probability of a September cut. This reduced policy uncertainty has dampened speculative positioning around the July meeting, pulling down options market volatility. In other words, while the euro still benefits from dollar hedging, the lack of ECB-driven volatility as a catalyst weakens the case for a sustained bullish EUR/USD uptrend. After all, lower ATM volatility tends to drag down wing volatility, having a multiplier effect that weakens appetite for aggressive euro bets and ultimately reins in momentum.
Meanwhile, the euro’s ambition to rival the dollar as a global reserve currency remains distant. The ECB’s latest annual report, released yesterday, showed international euro usage remained flat in 2024 at 19%, while its FX reserve share held steady at 20%—just a third of the dollar’s dominance. Though the report doesn’t yet reflect recent market shifts, it underscores the long road ahead for the euro to challenge the dollar’s role. Meanwhile, rising demand for crypto and gold, with the latter having recently overtaken the euro as the second-largest central bank reserve asset, adds further obstacles to broader euro adoption.
Sterling struggles as gilt yields diverge
George Vessey – Lead FX & Macro Strategist
The weaker US dollar allowed the pound to claw back towards $1.36, but this morning’s softer-than-expected GDP data has forced the UK currency to pare gains. Still, GBP/USD continues to trade in the higher echelons of $1.35, over six cents higher than its 5-year average. GBP/EUR is looking vulnerable though after slipping below key daily moving averages of late, as the euro sweeps up a chunk of the demand flowing away from the dollar.
Away from the trade drama, the UK data this week has been a drag on the pound. The British economy shrank 0.3% m/m in April, the first decline in six months, and the biggest since October 2024. Services output fell by 0.4%, following growth of 0.4% in March, and was the largest contributor to the fall in GDP. Industrial and manufacturing production also came in below forecasts. The gloomy numbers follow a sharp decline in payrolls, with over 100,000 jobs lost in May, and means the likelihood of an August Bank of England rate cut has solidified further. Markets are pricing in two more rate cuts this year now, and as a result, two-year gilt yields are expected to trend lower in anticipation of easier policy, which could prove a strong headwind for sterling.
Long-end rates are expected to stay elevated though. The three-year spending plan outlined by UK Chancellor Rachel Reeves yesterday suggest sustained demand on public finances raising the likelihood of further borrowing and potential tax hikes down the line. Hence 10- and 30-year gilt yields keep pressing higher, widening the divergence with 2-year yields.
Euro shines as trade risk ramp up
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 9-13
All times are in BST
Have a question? [email protected]
*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
Leave a Reply