On Tuesday, the risk-sensitive pound was influenced by renewed global risk aversion as investors sought safety in traditional safe-haven currencies like the US dollar, Japanese yen, and Swiss franc. This shift was triggered by the surprising outcome of India's election, where Narendra Modi lost his parliamentary majority.
Markets had anticipated a landslide victory as predicted by exit polls, but this result highlighted the unreliability of polls. The election outcome was much closer than expected, and the resulting coalition government spurred a wave of demand for safe-haven assets, boosting the Japanese yen. The yen was further supported by hawkish remarks from a Bank of Japan (BoJ) official, who hinted at scaling back bond purchases in the upcoming meeting this month. This led to a bullish shift in yen risk reversals across several tenors, indicating the strongest positive sentiment in weeks. As a result, USD/JPY fell to two-week lows, while GBP/JPY and EUR/JPY experienced their largest daily drops in over a month, with the former falling from ¥200 to nearly ¥197. Although the yen has since given up most of these gains, increasing volatility suggests potential for further strengthening amidst divergent monetary policies and political developments.
These recent political and monetary policy surprises underscore the sensitivity of certain currencies. Significant fluctuations can occur rapidly, especially with the yen. The British pound, also a risk-sensitive currency, is susceptible to substantial swings, particularly periods of weakness during heightened risk aversion. This is crucial to consider with upcoming central bank meetings and elections in Europe, the UK, and the US.
The euro depreciated for the first time since last Wednesday as risk-off safe-haven flows dominated the markets. German unemployment claims unexpectedly rose by 25,000, compared to the anticipated 10,000, while the unemployment rate remained steady at 5.9%. Despite this, investors have reduced their expectations for European Central Bank (ECB) policy easing this year, primarily due to the surprising inflation increases over the past two months. The inflation uptick in May led some policymakers to adopt a more hawkish stance, casting doubt on the likelihood of consecutive rate cuts in July.
Some central bankers, particularly from Germany, appear to have ruled out policy easing at the July meeting. However, ECB pricing still tends to follow the Federal Reserve. This means that a potential downturn in the US economy and the end of US exceptionalism could reintroduce some of the rate cuts that were previously priced out. Despite the recent depreciation, the euro is still on track to appreciate for seven out of the last eight weeks, influenced by last week’s persistent inflation report.
EUR/USD is holding above the $1.0880 level, but momentum will need to be confirmed by today's US ISM PMI data and Thursday’s ECB rate decision. Any significant positioning is likely to be cautious and limited ahead of the US labour market report on Friday.
