Foreign exchange trading reminder: the Federal Reserve's interest rate hike in June is expected to rise to support the dollar, and global optimism is driving the Australian and New Zealand dollars to recover

In early Asian trading on May 30, Beijing time, the dollar index fell slightly and is currently trading around 104.26. The dollar index fluctuated narrowly on Monday and finally closed up 0.06% at 104.28. The US debt ceiling agreement has boosted risk appetite in global markets and weakened the safe-haven appeal of the dollar.

President Joe Biden said on Sunday that he had finalized a budget deal with House Speaker McCarthy that would suspend the $31.40 trillion debt ceiling and send the deal to Congress for a vote.

The fall in the safe-haven dollar came as global stock markets rallied on positive news from Washington, but trading was subdued by holidays in parts of Europe, including the UK, and the US.

Charu Chanana, market strategist at Saxo Markets, said: "The initial reaction to heightened risk appetite may be due to the dissipation of US default suspicions. But the focus will quickly shift to the fact that reaching an agreement is just one step in the process and that reaching agreement between the House and Senate by June 5 remains a big issue." The deal would suspend the debt ceiling until January 2025 and limit budget spending for 2024 and 2025.

U.S. Treasury Secretary Janet Yellen said on Friday that the government would default if Congress did not raise the $31.40 trillion debt ceiling by June 5, after saying it could happen as early as June 1.

The US rate hike cycle may not end as soon as previously hoped as signs of a strong economy have supported and will continue to support the dollar, although concerns about the US debt ceiling have eased. The dollar index has risen 2.5% so far in May

The dollar index has risen 2.5 per cent so far in May after Friday's data showed that US consumer spending rose more than expected in April and inflation picked up, providing further evidence that the economy remains resilient.

The movement of the money market shows that the probability of the Federal Reserve raising interest rates by 25 basis points in June is about 62%, compared with the probability of raising interest rates digested a week ago.

The euro closed 0.17 percent lower at 1.0707 against the dollar on Monday, with no immediate reaction to news of Spain's election, which Prime Minister Pedro Sanchez said on Monday would be held on July 23 after his left-wing coalition government suffered a major setback in regional elections on Sunday.

Analysts at Natixis expect eurozone inflation to be significantly lower than in the US by the end of 2023, with core inflation falling below 3 per cent in the US and likely to remain above 5 per cent in the eurozone.

Weak growth in the eurozone is weighing on the euro. Activity in France looks set to slow across the board from the second quarter. With the labour market also showing early signs of weakness, business leaders taking a more pessimistic view, persistently high inflation, expectations of weak global growth and the impact of monetary tightening more pronounced, French GDP growth is likely to weaken in the coming quarters. Economist Klaus Westerson says the cut in Quarter 1 GDP in Germany may not mean further contraction in the coming quarters, but there are no signs of a strong recovery either. Quarter 1 GDP contracted by 0.3 per cent, less than initially expected, and higher interest rates and tighter credit standards are now starting to take their toll: investment falls and the surge in net exports fades away.

In addition, the continuous strikes in European countries, including Belgium, Italy, and Germany, to protest against high inflation have also had an impact on the euro zone economy, becoming another factor that is bearish on the euro.

Global optimism helped the risk-sensitive Australian and New Zealand dollars recover from six-month lows hit last week. The Aussie closed up 0.34% at 0.6538 against the dollar on Monday, while the New Zealand dollar closed up 0.12% at 0.6053 against the dollar.

Ray Attrill, head of foreign exchange strategy at National Australia Bank, said: "So far, we've seen a positive market reaction to a debt ceiling deal. Obviously, this debt ceiling deal still needs to be actually implemented, but I think the market is happy to accept the assumption that it will be implemented before the new deadline."

The dollar briefly touched a six-month high of 140.91 against the yen on Monday before falling and closing 0.11 percent lower at 140.43.

Nomura pointed out that since the market has now digested the expectation of further interest rate hikes by the Federal Reserve, it will be difficult for the dollar to continue its recent gains against the yen. The bank said that the market has now fully digested the expectation of the Federal Reserve to raise interest rates by 25 basis points in June or July, and the pricing of interest rate cut expectations has also decreased, which has eliminated the gap in views between the Federal Reserve and investors. At the same time, investor positions have also further shifted to shorting the yen. The combination of these factors may limit the rise of the pair around 142, and the rise to 145 seems more difficult. At the same time, when any new factors in the market point to a stronger yen, the dollar may face greater volatility against the yen, such as weaker-than-expected U.S. economic data.

Tuesday's key data and events

Institutional Perspectives Summary

1. Morgan Stanley: If Erdogan does not adjust the policy framework, the Turkish lira could plunge by 29%.

① Turkish President Recep Tayyip Erdoğan, who won re-election, could see the lira plunge by 29% if he sticks to his policy of keeping interest rates low.

② Morgan Stanley analysts wrote in a research note that without a change in policy direction, especially interest rate policy, the Turkish lira could fall to 26 against the dollar earlier than expected and further weaken to near 28 by the end of the year. The lira closed at 19.97 on Friday, near a record low against the dollar;

③ The analysts said: "Without adjustments to the macro policy framework and market-friendly policies, Turkey's high external financing needs could lead to persistent macro risks and increased sensitivity to global shocks (commodity prices and the Federal Reserve) and foreign exchange inflows from regional partners;"

2. UniCredit Bank: The market's interest rate hike expectations for the Federal Reserve may keep the European and American currency pairs depressed;

① UniCredit analysts said in a report that expectations are growing that the Federal Reserve will raise interest rates in July, while the possibility of a rate cut before early 2024 is decreasing, which should support the dollar and contain the euro from rising sharply above 1.08 against the dollar.

The chart analysis also shows that if the euro falls below 1.07 against the dollar, it may accelerate its decline to 1.05.

3. Capital Economics: After Erdogan's re-election, it is expected that the Turkish economy will become more unstable, and the lira may depreciate significantly.

① Capital Economics senior emerging markets economist Peach said that Erdogan's victory in the Turkish presidential election may push the Turkish macro economy to a more unstable path, and the lira may depreciate sharply;

Under Erdogan's leadership, low interest rates and loose fiscal policy have led to a series of imbalances in the Turkish economy, including high inflation, a large current account deficit, and severe external financing pressures.

③ Turkey's economy is barely performing in 2022, but cracks have appeared in recent months, and current policies look increasingly unsustainable; the dollar is expected to rise 25% against the Turkish lira this year to 26%.

4. Wells Fargo: The dollar has depreciated slightly this year, and the depreciation rate will accelerate next year.

Economists at Wells Fargo predict that the dollar will depreciate modestly in the fourth quarter of this year and accelerate next year; in the short term, the dollar may be relatively stable, as further tightening by the Federal Reserve and possible minor market volatility may provide temporary support for the dollar.

However, the bank expects the dollar to eventually come under pressure as the Federal Reserve embarks on aggressive easing from early 2024; its economists predict a 1.5% decline in the dollar index in 2023 and a further 5% decline in 2024.

5. UniCredit Bank: The prospect of the Federal Reserve raising interest rates may keep the dollar strong.

① UniCredit analysts said in a report that expectations of further interest rate hikes by the Federal Reserve should keep the dollar strong and limit its decline, even as the debt ceiling deal reached by US President Biden and House Speaker McCarthy dampens safe-haven demand.

② Analysts said: "We suspect that this [debt ceiling deal] may not be enough to significantly reduce the strength of the dollar over the past few weeks."

③ US money markets revived expectations for another Fed rate hike in July and sharply reduced the likelihood of rate cuts in late 2023 and early 2024, "which could continue to support the dollar."