FX Update: Big week ahead for FX as all G3 central banks meet.

FOMC: market underestimating likelihood of a hike? Tuesday CPI will weigh.
Yesterday’s hot jobless claims number of 261k (the first above 250k since November of 2021, assuming it is not revised below that level) moderated FOMC rate hike bets for next Wednesday’s FOMC meeting. The probability today is seen around 25-30% for a 25-bp hike. Next Tuesday’s May CPI figure is a far more important arbiter on whether the Fed hikes again than the weekly claims number. The last four consecutive Core YoY CPI numbers have printed at either 5.5% or 5.6%, slowing the prior decelerating trend, but with a cycle low of 5.3% expected for May. The headline is expected to moderate all the way to 4.1% vs. 4.9% in April as the most favourable YoY comparisons roll into view through June (June of last year saw the worst acceleration in gasoline prices, for example). If the core inflation number surprises on the high side for either the month-on-month or year-on-year readings, the Fed is far more likely to hike than to stand pat. Remember that the March FOMC economic projections are for the unemployment to rise to 4.5% and for the core PCE to have dropped to 3.3%. The April PCE was at 4.7%, essentially unchanged since the December print of 4.6%. Even with in-line CPI, I suspect the Fed hikes, but the more important factor could be the message in the newest projections we get next week, especially the inferred message from the combined “dot plot” forecasts of Fed policy combined with the PCE and other forecasts for this year and next. The USD likely rallies if the FOMC meeting upsets risk sentiment, whatever the reason.

ECB – no significant surprise side?
The ECB meeting next Thursday offers perhaps the least potential for drama, as the market almost universally expects that President Lagarde and company will hike 25 basis points and speak sternly on the need to keep up the inflation fight, while at the same time having to admit that the Eurozone economy is performing poorly. The official Q1 GDP for both Germany and the Eurozone were slightly negative and . A miss on the downside for the preliminary May estimate for Eurozone CPI also makes it easier for the ECB to simply deliver what the market is expecting and provide little fresh guidance. Citi’s measure of Eurozone economic surprises has reached a very low level at -90. Hard to see why the ECB needs to add any drama to its message next Thursday.

Bank of Japan – the most potential to jolt the market.
After Governor Ueda declared that the Bank of Japan would take up to eighteen months to conduct a policy review (beyond the other side of the next wage negotiation rounds next March), expectations for even modest policy tweaks is low. Still, given those low expectations and the trillions of Japanese investor savings that are always sloshing around global markets, any surprise tweak could deliver an outsized response. Recall that the December tweak of the 10-year JGB yield band to +/- 50 basis points from 25 basis points triggered a one-off avalanche in JPY crosses (USDJPY moved almost 700 pips in a single day=. The pressure is arguably on the BoJ to move on policy after the RBA and Bank of Canada have restarted policy tightening at recent meetings and Norges Bank is now eyed possibly hiking 50 basis points. If the Fed hikes next week, this ups the pressure even more. Again, odds may be theoretically low, but higher than the market expects, and the reaction function to any BoJ move here could prove far more intense than anything the ECB or even the FOMC are likely to deliver next week.

UK labor market data on watch next Tuesday
An important test for sterling also lies ahead next week. While Citi’s economic surprise index is a surprisingly positive +70 for the UK, one of the important economic data points that raised eyebrows last month was the labor market report, one that suggested the number of payrolled employees dropped out of bed in April with little warning with a drop of -136k, while the UK Jobless Claims in April ticked up to a post pandemic-disruption high of 47k. If we get another set of weak labor market numbers for May, it would likely temper the potential for the Bank of England to guide hawkish at the June 22 meeting. Presently, the 2Y2Y yield spread between the UK and the US (the difference between the market’s pricing of the 2-year rate, two years into the future) is near multi-year highs at over 70 basis points and at the top of the historical range (matching the spread during the Kwarteng-Truss mini-budget panic). That looks very stretched as the UK is priced to have a 2-year yield at this date in 2025 of 4.14% while the US is priced to have a 2-year yield of 3.43 at that time.

Table: FX Board of G10 and CNH trend evolution and strength.
The US dollar performance has gone flat, awaiting catalysts in the form of next week’s FOMC meeting, which could yet bring a hike even as odds of one have dropped to 25%. But the Bank of Japan has the most potential to jolt market volatility next week. Note the huge NOK comeback in momentum terms in recent days. CHF also firmer after SNB’s Jordan warned on inflation yesterday.

Table: FX Board Trend Scoreboard for individual pairs.
Extreme underperformance of SEK crosses faces a possible test next Wednesday on the Swedish CPI release. Some of the recent SEK weakness may be on negative Eurozone economic surprises. Note that EURNOK looks set to flip to a negative trend today, with GBPUSD probably needing next Tuesday’s US CPI and UK labor market data for a confirmation of direction.