Currency (Fx) Monthly Analysis June 2016

June is set to be a volatile month as markets await both the Fed’s June interest rate decision and the outcome of the UK’s EU referendum, to be held on the 23rd. At the time of writing, the EU referendum vote remains too close to call. The pound appreciated in the second half of May as polls indicated a lead for “Remain”, only to weaken heading into the start of June as new polls showed a lead for “Leave”. The pound will remain similarly vulnerable to Brexit headlines and polls in the final weeks ahead of the Referendum and will continue to experience volatility. Expectations surrounding a Fed rate hike will drive the dollar’s strength, while markets will look to the ECB and Eurozone data for guidance as to the euro’s direction.
The pound weakened at the start of May as disappointing Manufacturing, Construction, and Services PMI figures, which all fell to their lowest levels since 2013, halted the pound’s April gains. Later in May, the pound appreciated again as new polls showed a widening lead for “Remain”, increasing investors’ expectations that the UK might remain in the EU. However, the pound remained vulnerable to Brexit headlines and erased some of its earlier gains on the 31st as a new ICM poll put “Leave” in the lead. Other data out last month were mixed. Manufacturing Production and Industrial Production both rose less than forecast, while annual CPI inflation slowed to 0.3% from 0.5% and Core CPI y/y slowed from 1.5% to 1.2%. Positives included a 2.0% gain in Average Earnings, slightly greater than expected, as well as a 1.3% jump in Retail Sales after the previous month’s 0.5% contraction. The second estimate of Q1 GDP was unchanged at 0.4%.
The Referendum will be the primary motivator of the pound’s movement in June, while economic releases may provide additional movement on a day-to-day basis. The pound will likely experience further volatility and remain vulnerable to Brexit polls and headlines in the remaining weeks ahead of the Referendum, with its strength likely dependent on market expectations as to whether the UK will remain in the EU. This volatility will likely increase as the date of the Referendum nears, particularly if the vote remains close. Data to keep an eye on this month include CPI inflation, wage growth and unemployment, Retail Sales, and the final estimate of Q1 GDP growth. The Bank of England meets on the 16th for the final time ahead of the Referendum, and markets will look for forward guidance from Governor Mark Carney. The degree of sterling strength or weakness following the Referendum will depend on a variety of factors, including the decisiveness of the vote. The sustainability of any gains in the pound following the Referendum, should the UK vote to remain in the EU, will then be determined by data as attention returns to underlying economic fundamentals and the UK’s outlook on economic growth, inflation, and normalising interest rates.
The euro lost ground against both the pound and the dollar last month, largely due to shifts in Referendum and Fed expectations, which offered both the pound and the dollar support. With no ECB meeting last month, movement in the euro was largely driven by data. German Factory Orders rose more than expected but Industrial Production in both Germany and the Eurozone as a whole fell more than expected on a month-to-month basis. Final CPI figures confirmed inflation was at -0.2% and Core inflation at 0.7% in April, while Flash figures indicated CPI picked up to -0.1% and 0.8% respectively in May. Economic Sentiment unexpectedly fell in both Germany and the Eurozone last month, putting some pressure on the euro. However, the Business Climate in Germany picked up more than expected. Greece featured in headlines last month as it negotiated the next tranche of its bailout programme and tentative debt relief measures with its creditors; the situation has been closely watched for any deterioration that could lead to renewed Grexit fears.
Markets will keep a close eye on the ECB’s 2nd June meeting as headline inflation remains negative heading into the meeting. While no monetary policy adjustments are expected, markets will keep an eye out for any changes to projections for economic growth and inflation as well as any forward guidance on the ECB’s remaining tools if inflation remains low going forward. Inflation figures will remain closely watched, with Final May figures expected on the 16th and preliminary June figures expected on the 30th. Markets will also look for any improvement in Economic Sentiment and further gains in German Business Climate this month. The UK’s upcoming EU Referendum could have wider implications for the euro, particularly in the instance of a vote to leave the EU, which could prompt demand for the euro as a safe haven amidst the resulting political and economic uncertainty.
Investors’ expectations for a summer Fed rate hike rose in May, strengthening the dollar. In particular, the dollar gained after the Fed’s April meeting minutes were interpreted as being more hawkish than expected and Fed comments out in the following weeks emphasised that markets may have been underestimating the odds of a rate hike as soon as June or July. Fed Chair Yellen, in comments made at the end of the month, kept the door open for a summer rate hike, saying that it would probably be appropriate to raise rates again “in the coming months”.  Data highlights included above-forecast gains in Retail Sales, housing data, and Durable Goods Orders, as well as an upwards revision of Q1 GDP from 0.5% to 0.8% and a rise in CPI inflation from 0.1% to 0.4% m/m and from 0.9% to 1.1% y/y. Average Hourly Earnings rose 0.3% in April, as forecast, and although Non-Farm Employment Change was significantly lower than expected at 160K, the Unemployment Rate held at 5.0%. Unemployment Claims rose in the first half of May to as high as 294K before returning to 268K by the end of the month.
As the Fed’s meeting on 14-15 June approaches, markets will continue to pay close attention to both the data and the Fed’s comments out in the intervening time for guidance as to the Fed’s thinking heading into the meeting. Expectations for a June or July rate hike will be one of the primary driving factors of the dollar’s strength this month. As markets are currently pricing in a higher chance of a July rate hike than a June hike, movement in June would likely strengthen the dollar, while if the Fed holds off on raising interest rates, the dollar may weaken ahead of a renewed round of speculation on the chances of a July rate hike. Key releases to keep an eye on ahead of the Fed meeting include May’s jobs report, the Producer Price Index, and Retail Sales. The next CPI release is not expected until the 16th of June, following the Fed’s interest rate decision. If the Fed holds off on raising interest rates to await additional data confirmation and following the UK’s EU Referendum, the dollar may weaken, with room to strengthen again as markets begin speculating about the odds of a July rate hike. If the Fed raises interest rates in June, the dollar would likely appreciate.
Regards All.

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