The US dollar has weakened against most G10 currencies. GBP/USD has reached fresh 12-week highs above $1.28, while EUR/USD has reclaimed $1.09 for the first time since mid-March. This dollar weakness is due to declining yields following the US ISM manufacturing PMI report, which confirmed trends of slowing growth, decelerating inflation, and a tight labour market. Investors are closely monitoring data to assess how long the narrative of US exceptionalism can persist. The nonfarm payrolls report on Friday will be a critical event for cross-asset developments. Yesterday, the US manufacturing PMI surprised markets with a decline from 49.2 to 48.7 in May, impacting the US currency. Notably, the employment category showed improvement after seven months of contraction. JOLTS job openings will be important today, followed by services PMI on Wednesday and the eagerly anticipated jobs report on Friday

The key event this week will be the widely anticipated ECB policy rate decision on Thursday.

GBP fell from 21-month highs against the EUR following Friday’s release of higher-than-expected Eurozone inflation data, disrupting a bullish technical setup and raising the potential for a deeper pullback to £/€ 1.17 or lower at interbank.

The recent strength of GBP has been driven by diminishing expectations for a June rate cut by the Bank of England (BoE). Markets now do not fully anticipate a rate cut by August. In contrast, the European Central Bank (ECB) is expected to cut interest rates this week, creating a clear divergence in monetary policy between the UK and Eurozone that supports GBP gains. Since markets already anticipate an ECB rate cut on Thursday, the actual decision won't be surprising; instead, market movements will be influenced by guidance on future rate cuts.

In addition to central bank actions, economic data will also be in focus this week. China will release Caixin PMI numbers on Monday, Australia will report March-quarter GDP on Wednesday, and the US will build up to Friday’s non-farm payrolls (NFP) report.

Last month, the NFP report missed forecasts for the first time since October, triggering a USD sell-off and leading to the greenback's first monthly decline in 2024.

The US dollar gained mid-week due to rising Treasury yields, buoyed by strong economic data, hawkish remarks from Federal Reserve (Fed) policymakers, and a series of weak bond auctions. However, a sharp reversal in the dollar index occurred on Thursday following downward revisions of Q1 GDP and core Personal Consumption Expenditures (PCE).

US GDP growth for Q1 was revised down to 1.3%, aligning with expectations, primarily because of slower consumer spending, while PCE prices rose slightly less than initially estimated. Additionally, US jobless claims were slightly higher than forecasts and above the 2024 average. Market participants now anticipate only one rate cut by the Fed this year, with a 65% chance of a decrease in November and 83% in December, compared to 61% and 80% respectively before the release of the US economic data. The dollar index fell below 105, erasing the previous day’s gains and mirroring the decline in bond yields.

Currency markets appear to be engaging in range-trading in this low-volatility environment as investors await further economic data to determine when the Fed might begin its easing cycle. Today's release of the monthly PCE report – the Fed’s preferred measure of inflation – is expected to be a pivotal event, likely setting the next significant trend for the dollar. If inflationary pressures from the first quarter persist, the trend could turn upwards.

In other news, Donald Trump was convicted on all 34 counts of falsifying business records in a landmark criminal trial in New York. This marks the first time a former or sitting US president has been convicted of a crime. The verdict comes as Trump campaigns to unseat Joe Biden in the November election. Sentencing is scheduled for July 11; while Trump could face prison, legal experts suggest a fine is more probable. Nonetheless, Trump remains eligible to run for president, as the Constitution does not disqualify convicted criminals from holding the office. However, this outcome poses significant political risks for his campaign.

Deteriorating global risk sentiment pushed the euro down against its G10 counterparts. The STOXX50 index plunged to a three-week low, while European yields inched higher. The yield on Germany's 10-year benchmark bund climbed to 2.68%, reaching a six-month high, and the 2s/10s curve steepened to -36bps, nearing a three-week high.

May's preliminary report showed Germany's headline consumer inflation rate rising to 2.4% year-on-year, matching market expectations. This marks the first inflation increase in five months, driven by higher prices in services and food, despite further declines in goods prices. The core inflation measure, excluding volatile food and energy components, remained steady at 3% year-on-year. Monthly momentum slowed more than anticipated, dropping to 0.1% from 0.5% in the previous report, but the EU-harmonized inflation rate unexpectedly increased to 2.8% year-on-year, above the 2.7% forecast. Although this rise in the harmonized measure is unlikely to prevent the ECB's expected rate cut next Thursday, it raises concerns about the central bank's flexibility for further easing in the second half of the year. The ECB's Governing Council appears divided, with most policymakers hesitant about a consecutive rate cut in July, while France's Villeroy suggested not ruling out such a move.

In the currency markets, EUR/GBP dropped as much as 0.3% to 0.84838, its lowest since August 2022, before recovering, as the Bank of England is increasingly expected to lag behind the ECB in cutting interest rates. EUR/CHF retreated from multi-month highs, and EUR/USD fell by over 0.4%, marking its largest one-day drop this month, though it remains supported at its 100-day SMA. As we approach the ECB's rate decision on June 6, sentiment towards the euro is turning more bearish. One-week EUR/USD risk reversals are now the most euro-negative in nearly four weeks.