Mixed Market Reactions Amidst Uncertainties in Russia and Inflation Concerns | Daily Market Analysis

Key events:     

• Eurozone - ECB President Lagarde Speaks                        
• USA - Building Permits     
• USA - Core Durable Goods Orders (MoM) (May)     
• USA - CB Consumer Confidence (Jun)         
• USA - New Home Sales (May)                            

On Monday, US stocks concluded the day with a decline as investors exercised caution in their approach towards riskier assets due to uncertainties surrounding the outcome of the disrupted mutiny in Russia over the weekend.

The mutiny led by Russian mercenaries sparked concerns about the future of President Vladimir Putin. Although Putin expressed gratitude on Monday towards the mercenary fighters and commanders who chose to stand down and prevent bloodshed, the US State Department emphasized that the situation in Russia remained fluid and unpredictable.

Among the primary indices, growth stocks exerted significant downward pressure, resulting in sharp declines for Meta Platforms Inc (NASDAQ: META), Alphabet Inc (NASDAQ: GOOGL), and Tesla Inc (NASDAQ: TSLA).

Currently, there are no clear signals in the foreign exchange market indicating a strong preference for safe-haven currencies like the US dollar, Japanese yen, or Swiss franc. This lackluster response can be attributed to two main factors. Firstly, there is uncertainty about the future following the challenge to President Putin's authority in Russia. Secondly, financial markets have already experienced a year of a stronger dollar and higher energy prices due to the Russian invasion of Ukraine.

Instead, the market's primary focus is on inflation. Central bankers and governments are facing criticism for maintaining loose monetary and fiscal policies for an extended period. The upcoming annual ECB symposium in Sintra will center around this topic, particularly monetary policy. It is expected that many central bank governors from the G7 nations will attend and deliver a hawkish message similar to Federal Reserve Chair Jerome Powell's recent testimony to Congress.

As a result, it is anticipated that yield curves will remain inverted as investors evaluate the potential for an approaching recession. The US dollar is expected to maintain its strength against currencies that lack robust monetary defenses. Specifically, the USD/JPY currency pair is likely to continue its upward trend. Another significant event taking place in the United States this week is the release of core PCE inflation data for May, scheduled for Friday. Should the data reveal another high reading, especially around 0.4% month-on-month, it would suggest that the Federal Reserve will continue its hawkish stance without indicating any plans for easing.

According to forecasts, the US Dollar Index (DXY) is projected to fluctuate between the range of 102.00 and 103.00 throughout this week. Additionally, the USD/JPY pair is expected to approach the intervention zone around 145.

On the previous Friday, Europe experienced discouraging data regarding the Purchasing Managers' Index (PMI), primarily in the services sector, which indicated a decline. This corresponds to the already sluggish state of the manufacturing sector. As a result of this data release, the EUR/USD currency pair witnessed a decrease of approximately 50 pips.

Initially, the narrative of central banks needing to maintain higher interest rates for an extended period may not appear favorable for the pro-cyclical Euro. However, the hawkish stance adopted by the European Central Bank (ECB) has offered some defense against the elevated interest rates in the United States, leading to the EUR/USD currency pair rising above 1.09. This stance also reinforces the expectation of two additional 25 basis points rate hikes in July and September, potentially counterbalancing the modest easing anticipated in 2024.

Considering the current circumstances, it is likely that EUR/USD will continue to trade within the range of 1.0850 to 1.1000, while the desired outcome of a smooth economic transition and a more accommodating policy from the Federal Reserve seems to be further delayed.

Presently, the financial press extensively discusses the challenges faced by central bankers as they navigate the shift from a relatively straightforward decline in headline inflation driven by base effects to the more complex task of reducing core inflation. Many countries are witnessing core inflation rates around 5%, while the Bank of England is contending with an even higher rate of 7%. Given this situation, it is expected that Bank of England officials will not hesitate to price the Bank Rate above 6% early next year. Additionally, it is anticipated that the government will maintain its stance on mortgage interest relief, as compromising on this issue would only complicate the Bank of England's efforts.

The recent decline in Eurozone PMI data on Friday led to a decrease in EUR/GBP. Despite concerns about a potential hard landing for the UK economy, my initial analysis remains unchanged regarding the Bank of England's response.

Turning to the UK calendar for this week, the main focus will be on Bank of England speakers, with BoE Governor Andrew Bailey's event on Wednesday taking the spotlight. It is anticipated that EUR/GBP may experience a retreat and potentially reach the level of 0.8520 during the week. Furthermore, GBP/USD is expected to find support below 1.27.