Fed Dot Plot Key to EUR/USD, Outweighs EU Vote Impact

Key Takeaway

• Euro faces downward pressure due to political uncertainty in Europe, particularly after Macron's call for a snap legislative ballot.
• The Fed's upcoming dot plot is crucial; market expects 35 basis points of U.S. rate cuts this year, potentially supporting the euro.
• Global markets are volatile with rising U.S. Treasury yields and mixed reactions in Asian equities amid central bank policy shifts.

Euro Faces Political Uncertainty

The euro is experiencing heightened volatility following recent political developments in Europe. French President Emmanuel Macron's call for a snap legislative ballot has added to the uncertainty, especially after significant gains by far-right parties in the European Parliamentary elections. This political instability is expected to exert downward pressure on the euro, particularly as European traders react to the news. "Political uncertainty is never good for any currency, so risks are skewed towards the euro weakening further Monday," noted Mark Cranfield, a market analyst.

Despite these challenges, the euro's performance this week will largely hinge on the Federal Reserve's upcoming dot plot. The market is currently pricing in approximately 35 basis points of U.S. rate cuts this year. If the Fed signals two interest-rate cuts in its June dot plot, it could lead to a weaker dollar, thereby providing some support for the euro. "The common currency may underperform in the very near term, but the Fed’s dot plot looms this week -- the markets’ main focus," Cranfield added.

Fed's Dot Plot Anticipation

The Federal Reserve's policy meeting and the subsequent release of its dot plot are the primary focus for traders this week. The dot plot will reveal whether the Fed's views align with market expectations for interest rate cuts. Recent U.S. jobs data has led traders to anticipate a single rate cut in December. However, the Fed may opt to signal two cuts to keep its options open, given that there is still over half the year left. This approach would allow the Fed to adjust its stance based on economic data over the coming months.

"If inflation continues to be a problem by September, they can then dial back their easing expectations to one or maybe no rate cuts this year," explained David Finnerty, a financial analyst. The release of U.S. inflation data this week will also play a crucial role in shaping the Fed's decision. Two consecutive months of easing prices could weaken the dollar, making the euro more attractive to investors.

Global Market Reactions

The anticipation of the Fed's dot plot and U.S. inflation data is causing heightened volatility in global markets. The Bloomberg Dollar Spot Index has risen for the third consecutive day, with the Treasury 10-year yield nearing 4.45%. Meanwhile, Euro Stoxx 50 futures are down about 0.4%, and French bond futures have slid following Macron's announcement of a snap legislative ballot.

In Asia, Japan's Government Bonds (JGBs) are under pressure as the Bank of Japan (BOJ) sets the stage to reduce JGB purchases. Bloomberg Economics expects BOJ Governor Ueda to prepare the market for a potential rate hike in July, although there is some contention among BOJ members. The yen remains weak, and without aggressive action from the BOJ, it is unlikely to gain significant traction.

China's equities are also seeking new catalysts as the initial optimism from recent policy announcements wanes. Sustained support from policymakers is crucial, especially if economic indicators such as monetary and CPI data continue to reflect sluggish growth. In contrast, India's stocks may gain traction now that election-related uncertainties have subsided, with Prime Minister Narendra Modi prioritizing economic reforms to attract foreign investors.