May Market Update

May Review

Last month we talked about the unprecedented weakening of the dollar since October 2022. At the end of April, the greenback had dropped 15% and 14% against the euro and pound, respectively and at the beginning of May, it looked on course to continue to unwind all of the ground it gained versus EUR and GBP in 2022.

So, it was a big surprise when suddenly, in the second half of May, the dollar’s fortunes dramatically changed course. 

What happened? 

Analysts are crediting two incidents as the cause of the turnaround.

The US Debt Ceiling 

Perhaps counterintuitively, the US “debt ceiling”, creeping closer and closer, has actually bolstered the dollar. This is because it’s regarded as a safe-haven currency, and with the resulting instability in the market and the wide-ranging effects of US government default, there has been a move away from riskier assets and into the safety net the dollar provides for many investors, thanks to its status as the world’s reserve currency. 

Even so, negotiations over the last two weeks have been fraught. Not even Treasury Secretary Janet Yellen knew exactly when US treasury funds would run out. Still, her stark warnings and moving ‘X-date’ timeline has meant negotiations between leading Democrats & Republicans have been heavily in the spotlight over the past two weeks. 

A Dovish European Central Bank

Many analysts have also suggested that euro weakness, driven by dovish ECB officials, in fact, started the trend of USD strength, which then gathered further momentum due to the ‘risk off the table’ situation described earlier.

This has been compounded by a series of weaker economic data from the single currency, culminating in Germany, Europe’s largest economy, falling into a technical recession last Thursday.

Chicken or the egg, the outcome of the FX markets, has caused an abrupt change in the fortunes of GBP/USD and EUR/USD, which have dropped roughly 2.9% and 3.9%, respectively.

June outlook

Looking forward to June, we now expect the negotiations to conclude and the debt ceiling to have been raised before Secretary to the Treasury Janet Yellen’s ‘X-date’ (currently set for Monday, 5th June). The date marks the day the US would default on its debts, shattering the long-held view that US Treasury debt is ultra-safe. The possible consequences of the US’s first default in history could not only see stock markets collapse, unemployment rage, and the social security payments of millions go unpaid but also send shockwaves throughout the entire global economy.

Thankfully, discussions on the debt ceiling are then expected to conclude for another two years at least - and most notably until after the next US election.

This should alleviate some investor fears, but we know that, unlike in physics, every action does not have an equal and opposite reaction in the markets. In other words, we can’t guarantee a resolution will cause USD to weaken back to where it was before the whole situation started.

We are into the next phase of the monetary policy cycle now, making it much more exciting for the neutral spectator. We will be asking now, ‘Will they raise or hold interest rates?’ rather than ‘How much will they raise by?’

The results, particularly if they diverge from market expectations, can lead to changing demand for currency.

To find out what happens, look out for the next key central bank meetings in June:

• US Federal Reserve - Wednesday 14^th June
• European Central Bank – Thursday 15^th June
• Bank of England - Thursday 22^nd June

Hold on to your popcorn folks – we’re in for a volatile ride!

None of the information contained in this article constitutes, nor should be construed as, financial advice.

All data sourced from Bloomberg unless otherwise stated