The USD surged from its two-week low yesterday following remarks by Minneapolis Federal Reserve President Neel Kashkari suggesting that rate cuts might not be necessary this year if inflation remains subdued.  This week has seen significant developments on the macroeconomic front, with Eurozone inflation continuing its decline and the ISM PMI surveys indicating a gradual convergence between the manufacturing and services sectors. However, the primary concern for central banks globally and the current low-volatility environment stems from the recent rise in commodity prices, the USD, and inflation expectations.

This interconnected trio of challenges for risk assets demands close monitoring in the weeks ahead, particularly as the Stoxx 600 European equity index just experienced its most negative week in over two months.  Looking forward to today, volatility is expected to increase around the release of the jobs report for two main reasons. Firstly, the non-farm payrolls report has consistently been the most volatility-inducing data release globally for several years.  Secondly, recent months have witnessed staggering revisions to the initial numbers, with an average downward revision of jobs growth for seven months since the start of 2023, with revisions typically reducing the initial figures by 7%. Notably, December's figures were revised upwards by 74 thousand jobs while January's figures were revised downwards by 124 thousand.  Given this volatility in the data and market reactions, similar fluctuations are anticipated today.

Recent hawkish adjustments to Fed policy expectations, coupled with Chairman Powell's apparent inclination towards a June rate cut, suggest that the risks to the USD after today's US jobs report may lean asymmetrically towards the downside.  In simpler terms, a weaker jobs report could potentially weaken the USD more than a stronger report would strengthen it.

The US Unemployment Rate is projected to remain unchanged at 3.9% during the same period. Meanwhile, Average Hourly Earnings, a key indicator of wage inflation, are expected to increase by 4.1% in the year ending March, showing a slight deceleration from February's growth of 4.3%.

Following yesterday's dip in the US services PMI, the dollar index saw further declines, marking its steepest two-day fall in a month. Despite a promising start to the week with an uptick in the US manufacturing PMI, featuring a notable rise in inflation, the services sector failed to mirror this trend. March witnessed the services sector experiencing its slowest price growth in four years. Although employment showed a slight increase, it remained in negative territory, shifting attention towards declining price pressures, supplier deliveries, and backlogs.

Market participants are now eagerly awaiting the US unemployment claims data due today and the non-farm payrolls report due on Friday, bracing themselves for potentially turbulent market movements. FX options implied volatility gauges highlight the perceived risk of heightened FX volatility, with upcoming events such as Friday’s US jobs report and next Wednesday’s US inflation print factoring into market anticipation.

The decline of the pound from $1.28 to approximately $1.25 against the USD in recent weeks led to a breach of several crucial moving average support levels, revealing increased downside potential. However, following yesterday's release of US data and dollar weakness, the pound managed to extend its recovery from seven-week lows, reclaiming ground above the 200-day moving average – a bullish development.

The response to the impending US jobs report could prove pivotal in determining whether the currency pair returns to the higher ranges of its narrow year-to-date spectrum or ventures towards fresh lows. Fundamentally, it seems investors may have accepted the notion of the Federal Reserve maintaining higher interest rates for an extended period, given that less than three rate cuts are currently being anticipated. Hence, unless US data presents a significant upside surprise, further gains for the dollar might prove elusive, thus mitigating downside risks for GBP/USD. It's worth noting that historically, GBP/USD has seen an average rise of over 1% during the month of April over the past two decades.

The EUR staged a recovery from its seven-week low, surging past the $1.08 mark, propelled by a stumble in the USD against major currencies, spurred by lackluster services sector data. Initially, EUR/USD faced downward pressure following less-than-anticipated flash CPI prints. Meanwhile, European shares edged closer to multi-decade highs attained last week.

Yesterday saw a notable recovery for GBP following its recent dip to nearly two-month lows against the USD earlier in the week.  Updated figures unveiled a significant surge in the UK manufacturing Purchasing Managers' Index (PMI), reaching its highest level in 20 months in March, indicating a modest uptick in activity. However, the prevailing market sentiment now leans towards the likelihood of the Bank of England (BoE) implementing more cuts than the Federal Reserve in 2024. Consequently, GBP's yield advantage has diminished, constraining its potential for upward movement.

The manufacturing PMI surpassed the crucial threshold of 50, indicating expansion for the first time since July 2022.  Despite this positive development, the rebound faces challenges from tighter fiscal policies, the delayed effects of previous interest rate hikes, and subdued global demand.  The final PMI survey revealed that escalating transportation costs, stemming from ongoing disruptions in the Red Sea, contributed to the sharpest increase in input prices in a year. Moreover, there are indications that these cost escalations are being passed on to consumers. Nonetheless, the influence of downward pressures from other factors should keep UK Consumer Price Index (CPI) inflation on a downward trajectory in the upcoming months. Additionally, data released by the British Retail Consortium this week showed that shop price inflation in the UK eased from 2.5% in February to 1.3% in March - its lowest level in over two years, with food inflation decelerating to 3.7% from 5.0% previously.

Market forecasts now suggest a 52% probability of the BoE implementing rate cuts as early as June, with a cut fully priced in for August. GBP/USD continues to be restrained below its 200-day moving average due to the convergence of UK-US rate differentials, while GBP/EUR remains within a narrow trading range, hovering around €1.16. If Thursday's final services and composite PMI figures confirm robust readings for the UK, the sterling may receive additional support, particularly against the EUR.

The EUR remained near a three-week low, hovering around the $1.0750 mark against the USD, as investors brace for potential policy easing by the European Central Bank (ECB) compared to the Federal Reserve this year.  Money markets have raised their expectations of future ECB rate cuts, pricing in a 91 basis point reduction for 2024, following German data indicating a significant slowdown in inflationary pressures in Europe's largest economy.

Preliminary reports indicated that the headline inflation rate in Germany dropped to a nearly three-year low, declining to 2.2% year-on-year in March from 2.5% year-on-year in the previous month.  This decline was primarily driven by a sharp disinflation in the goods sector, with energy costs decreasing at a faster rate and food prices experiencing their first decline in nine years. Meanwhile, services inflation remained resilient, rising by 3.7% year-on-year (up from 3.4% year-on-year in the previous month), but core inflation eased further to 3.3% year-on-year, reaching its lowest level since June 2022. Despite progress in realized inflation, the latest ECB survey indicated that expectations for inflation three years ahead remained unchanged at 2.5%, with uncertainty surrounding inflation expectations remaining steady. Given the potential self-fulfilling nature of inflation expectations, sustained anchoring of long-term inflation expectations above the ECB's 2% target could raise concerns for the Governing Council in the future.

Market attention will be focused on the preliminary Eurozone inflation data for March later today.  With flash reports for the bloc's two largest economies already showing downside surprises, there is a significant risk that the headline rate for the Eurozone as a whole could follow suit, which would likely weigh on the euro. However, Federal Reserve Chair Jerome Powell's speech later today is expected to have a more lasting impact on EUR/USD, potentially increasing realized volatility as a result.  Overall, EUR/USD closed the first quarter down by 2.8%, marking its worst performance in a first quarter since 2021. Nevertheless, seasonal effects may soon favour the common currency, as historically, EUR/USD tends to appreciate on average during the month of April.

The week kicked off with Europe and many other parts of the globe still relishing their extended Easter holiday.  Despite the lack of economic data releases outside of the US, there was no shortage of market activity.  The unexpected uptick with the US ISM manufacturing PMI data injected some volatility into currency markets.

With the robust US data setting the tone early in the week, GBP was weaker against the USD, breaching several key support levels.  This downward shift suggests the potential for further decline in GBP/USD in the short term.  Having dropped nearly 3% from its 7-month peak in early March, the currency pair is nearing its 2024 lows around $1.25, dashing hopes for trading near $1.30 this spring.

Historically, April is a strong month for GBP against the USD. However, the opening day of the month saw GBP/USD slide approximately 0.7%.  While past instances of GBP closing below this crucial level have seen recoveries leading to a gradual return toward the upper half of its year-to-date range, this time is different.  The breach of its 50-week moving average, a support level in place since mid-November, adds to the bearish sentiment.  These technical signals, coupled with bullish speculator sentiment towards GBP, paint a gloomy picture for GBP.

On the fundamental front, declining UK inflation has shifted rate expectations earlier, aligning with those of the Fed and ECB in June. There's even a small but noticeable speculation that the BoE could be the first of the three to cut rates in May.

With no significant economic releases expected from the UK this week aside from final PMI numbers, GBP/USD will be heavily influenced by US data. Yesterday's positive US ISM report drove US yields to 3-month highs and bolstered the USD.  Should this week see a strong round of US jobs data, the decline in cable could accelerate, with the major support level at 1.25 likely to face a test.