Currency Markets

Dollar Index Performance

The dollar index rose by 0.23% over the week, primarily driven by the continued weakness of the yen. The index received additional support on Friday amid rising concerns about inflation, unemployment, and interest rates, suggesting that the US central bank may face further challenges ahead.

EUR/USD

The EUR/USD pair fell by 0.07% on Friday, retreating from its high of 1.0791. This decline occurred at the confluence of significant technical indicators, including the 200-day moving average, the downtrend line from the March, April, and May highs, and the 50% Fibonacci retracement of the March-April slide.

Treasury Yields and Inflation

Treasury yields rebounded following comments from Dallas Federal Reserve President that the current policy might not be restrictive enough to combat inflation. This hawkish sentiment was further supported by the University of Michigan’s inflation expectations, which rose sharply to 3.5% from 3.2% in April, marking the highest level since November 2023.

Consumer Sentiment

Overall consumer sentiment fell from 77.2 to 67.4, reaching its lowest point since November. The decline in sentiment is primarily attributed to growing inflation concerns.

Japanese Yen and Intervention Risks

The yen rose by 0.2% on Friday and 1.7% for the week, recovering from last week’s sharp decline caused by suspected intervention and weaker US labor data. The midpoint at 156.05 remains a critical level, with prices supported by a rebound in Treasury-JGB yield spreads.

Japan’s Ministry of Finance (MoF) and Bank of Japan (BoJ) have continued to discuss potential actions to prevent the yen from further weakening, similar to its dip in late April to levels not seen since 1990. However, the market is only pricing in 22 basis points of Japanese rate hikes by year-end, and the 2-year JGB yields at 0.31% do not suggest much more tightening next year. The intervention threat is perceived to be highest if the USD/JPY pair again approaches the 1990 high of 160.35.

Key Upcoming Events

Key for the USD/JPY pair and demand from carry traders are upcoming US data and Federal Reserve expectations, with the May 15 CPI and retail sales reports being the top event risks.

Fed Rate Expectations

Futures are currently pricing in 41 basis points of Fed rate cuts by year-end, down from 45 basis points before the latest hawkish developments. This is within the context of repeated data indicating that the hot US labor market is cooling off and may eventually test the Fed’s dual policy mandate.

Sterling

Sterling rose by 0.05%, supported by unexpectedly positive data. Friday’s high of 1.2541 coincided with the tenkan line crossing above the kijun on Monday, indicating a bullish trend. Sterling’s gains on Friday were more due to risk-on flows, as Gilt-Treasury yield spreads were slightly more negative. The Bank of England is priced to cut rates in August and by 55 basis points by year-end.

Other Currencies

USD/CAD

The USD/CAD pair fell by 0.04%, maintaining a portion of its earlier slide on much stronger-than-forecast data.

Australian Dollar

The Australian dollar fell by 0.2% in response to the rise in Treasury yields and the drop in key commodity prices.

The US dollar strengthened over the week amid rising concerns about inflation and interest rates, while the yen showed signs of recovery. Key events to watch include upcoming US CPI and retail sales data, which will provide further insights into the Fed’s policy direction. Other major currencies showed mixed performances, with sterling benefiting from positive data and the Australian dollar declining due to commodity price movements.