Odds of Donald Trump winning a second term as president have risen to about 67%, up from 60% prior to the assassination attempt on the former president over the weekend. The market reaction has been relatively muted so far, but the yield on 30-year Treasuries has surpassed that of two-year notes for the first time since January, driven by expectations that Trump’s policies will spur economic growth. Markets are now grappling with the concept of the “Trump Trade,” which reflects the anticipation of a pro-business environment and significant economic boost through fiscal stimulus. This scenario could limit the extent of Fed rate cuts, helping the dollar maintain its high growth and yield advantage. However, we believe US macroeconomic factors could be a more significant driver of the FX market through the summer. Recent data points to easing inflation, a cooling labour market, and moderating consumer spending, raising concerns about a potential abrupt US slowdown and a more dovish Fed, which may weigh on the dollar.

Recent softer economic data, including broad-based weakness in the June CPI, have increased the likelihood of two Fed rate cuts this year. Additionally, the modest decline in manufacturing conditions reported in the New York Fed’s Empire State Manufacturing Survey suggests the ISM Manufacturing PMI for July could also soften. Today’s focus is on US retail sales, which are expected to show a third consecutive month of weak spending due to high borrowing costs and a cooling labour market.

The British pound has pulled back slightly from its highest level in a year against the US dollar, remaining just below the crucial $1.30 mark. Meanwhile, GBP/EUR is hovering around the €1.19 threshold after reaching an almost two-year high yesterday. The next three days will bring critical macroeconomic data that could significantly influence the pound’s recent positive trend.

Currently, the pound appears unusually attractive compared to other currencies, driven by optimism surrounding the new Labour government, in contrast to political uncertainties in France and the US. UK Prime Minister Keir Starmer plans to use the upcoming King’s Speech to highlight his government’s initiatives to boost economic growth. This improving growth outlook is reducing expectations for interest rate cuts, while other countries lean towards easing. Investors now see a 48% chance of a rate cut in August, down from 60% at the beginning of the month. Key UK data releases that could impact the Bank of England’s monetary policy outlook are on the horizon, starting with inflation on Wednesday, labour market data on Thursday, and retail sales on Friday.

A busy week lies ahead, filled with significant data releases, events, and Q3 US earnings reports, all with the potential to move markets.

The ECB is expected to keep interest rates unchanged at Thursday’s meeting but will likely provide further guidance suggesting rate cuts at the September 12 meeting. Financial markets are currently pricing in an additional 45 basis points of rate cuts for 2024.

Next week's economic calendar is dominated by inflation reports from Canada, the UK, the Euro Area, and Japan. Additionally, China's Q2 GDP, UK employment data, and German and Euro Area ZEW sentiment readings will be released. These data points will be spread throughout the week, adding volatility to various FX pairs. If this week’s inflation and wage figures are supportive, we forecast GBP/EUR to reach a target of 1.1985 in the coming days. However, if the data falls short, a decline to our downside target of 1.1768 is possible. Friday’s Retail Sales report is also crucial, with forecasts for June at approximately -0.6%, compared to a solid 2.9% previously. Any positive reading is likely to support Sterling.

Pound Sterling’s strong performance has placed it at the top of the G10 currency basket for 2024, though challenges remain. An overbought Pound will be increasingly vulnerable to disappointing data releases (excluding England’s disappointing performance against Spain!).

Across the pond, The week has begun with a stronger US dollar, driven by the renewed "Trump trade" following Saturday's assassination attempt on the former president. This development increases the likelihood of a Trump victory, and his proposed tax cuts and trade tariffs, which are viewed as inflationary, may compel the Federal Reserve (Fed) to maintain high US interest rates for a longer period.

The two-year Treasury yield dropped more than 12 basis points, falling from 4.62% to 4.50%, and the US dollar index hit a five-week low after the US CPI report revealed inflation slowed more than expected last month. Earlier in the week, Fed Chair Jerome Powell indicated that the central bank needed more confidence in the inflation slowdown before adjusting rates. This CPI report may provide that reassurance. Softer economic data in recent weeks have further fuelled concerns about a sudden US slowdown. Consequently, traders now anticipate up to 60 basis points of rate cuts this year, suggesting two definite cuts and a potential third. The dollar is naturally under pressure, with the 104 level on the DXY being a key support focus. If the US 2-year yield remains at 4.5%, it could limit further losses, but the bond market's expectation of more cuts extending into 2025 may keep the dollar under pressure.

In a surprising turn for many investors, major US equity indices saw a sharp decline, with the Nasdaq dropping 2%, marking its weakest day since mid-April. This is the worst reaction to an inflation disappointment since the Fed began raising rates in early 2022. One interpretation is that the market had already priced in much of the anticipated good news regarding Fed rate cuts. Alternatively, the market may not have adequately discounted easier policy, and the inflation report now provides the Fed with a mandate to cut rates. This shift has moved capital from the overbought tech sector into value and small-cap stocks, resulting in the Russell 2000 having its best week of the year so far.

The specific reason for the capital reallocation is less critical to our macro thesis and the declining US dollar. Inflation declined on a monthly basis for the first time since the pandemic. Persistent indicators like core, shelter, and services inflation continued to ease in June as the headline figure fell to 3.0%. Heading into the last day of the week, attention will turn to the producer price index, which is expected to increase from 2.2% to 2.3% in June. This aligns with our assumption of continued disinflation in the consumer sector while reflation in the industrial sector begins to build. This could pose a problem for the Fed in the future. For now, the market welcomes the news of lower inflation.

Sterling surged over a cent against the US dollar to $1.2949 yesterday, marking its highest level since July 2023 and surpassing its key 200-week moving average of $1.2850. If it closes the week above this level, it could trigger further gains. This climb was fuelled by hawkish comments from Bank of England (BoE) policymakers, stronger UK GDP data, and a softer US inflation report.

The pound has outperformed all its major peers this year due to expectations that the BoE will need to maintain interest rates at 16-year highs for an extended period, driven by a surprisingly robust economic recovery and persistent concerns about stubborn services inflation and wage pressures. The UK economy grew by 0.4% in May, double the expected rate, positioning Britain for another solid quarter of expansion after leading the G7 in GDP growth in Q1. While some central banks are already cutting rates, the BoE has suggested that an August rate cut may be unlikely as inflation is expected to rise again. Money markets currently predict about a 50% chance of a cut in August and 49 basis points of easing by the end of the year.

This outlook bodes well for the pound, which is also buoyed by optimism that the newly-elected Labour government will bring political stability and a prudent approach to national finances. Adding to the pound’s recent strength was data showing that US inflation cooled last month, increasing expectations of more Fed rate cuts this year and next.

The Pound Sterling surged after the UK's GDP growth exceeded expectations in May, reducing the likelihood of an interest rate cut on August 1. The Pound to Euro exchange rate climbed to a one-month high, while the Pound to Dollar exchange rate reached a four-month high following the ONS report that UK GDP rose 0.4% month-on-month in May.

This increase more than doubled the consensus estimate of 0.2% growth and surpassed April's stagnant 0% reading. The growth was primarily driven by the services sector, the largest in the UK economy, which saw output increase by 0.3% in May 2024.

As a result, the UK economy grew by 0.9% in the three months to May 2024 compared to the previous three months, with services output rising by 1.1%. These figures indicate a robust ongoing economic recovery in the UK, reducing the need for the Bank of England to intervene with an interest rate cut.

May marked the fourth increase in GDP over the past five months. Ashley Webb, UK Economist at Capital Economics, notes that this trend supports the idea that the negative impacts of higher interest rates and inflation are beginning to diminish. Capital Economics now projects that GDP for the second quarter is on track for a 0.7% quarterly increase, matching the first quarter's growth.

As of 8am today, GBP/USD rallied to 1.2863, and GBP/EUR reached 1.1867.