Dollar-Yuan Set for Volatile Week Amid Fed, CPI Events

Key Takeaway

• USD/CNH is poised for a higher trading range, driven by Fed meeting and inflation data from China and the US.
• Rising US yields strengthen the dollar, pressuring Asian currencies; CNH forwards indicate pessimism towards the yuan.
• Increased FX volatility expected due to US CPI data, FOMC meeting, and geopolitical events in Europe and Japan.

USD/CNH Trading Range Outlook

The USD/CNH currency pair is poised to enter a higher trading range this week, driven by significant event risks including the Federal Reserve meeting and inflation data releases from both China and the United States. Investors are closely monitoring the People's Bank of China (PBOC) for any signs of continued intervention to restrict yuan movement through the daily fixing. Despite these expectations, CNH forwards indicate a more pessimistic outlook for the renminbi.

A divergence in the offshore forwards curve is evident, with one-year contracts moving in the opposite direction to one-month contracts, suggesting a negative stance among traders towards CNH. Currently, the spot USD/CNH is near the upper end of its price range since March. Additionally, China's upcoming inflation data is expected to support the case for the PBOC to maintain an accommodative monetary policy.

The onshore-offshore spread has been widening, though it remains below levels that would deter yuan bears. This widening spread is likely to encourage USD buyers, especially if the euro faces additional pressure due to the upcoming French elections. Should the USD/CNH reach the 7.28 level this week, it could signal the beginning of a higher trading range.

Asian FX Volatility

Asian currencies are expected to face increased volatility this week, influenced by a selloff in US Treasuries and the looming US CPI data and Federal Open Market Committee (FOMC) meeting. Market sentiment is leaning towards a potential US interest rate cut in December, and the Fed's dot plot will reveal how recent data has influenced official perspectives.

The euro is also under scrutiny following significant electoral setbacks for leaders in France and Germany in the European Parliament elections. French President Emmanuel Macron's decision to call a snap legislative ballot adds to the uncertainty. Japan's yen remains vulnerable, with the Bank of Japan (BOJ) possibly discussing a reduction in bond-buying operations and hinting at a July rate hike. However, the yen's trajectory will largely depend on the FOMC's decisions.

In India, the reappointment of Prime Minister Narendra Modi is expected to stabilize the nation's assets. Foreign investors are cautiously optimistic, awaiting confirmation that the new administration will continue its economic reforms and pro-growth agenda. Data as of June 6 indicates cautious sentiment towards equities, while bond market flows remain stable, supported by the central bank's focus on currency stability.

US Dollar Strength

The US dollar continues to strengthen, driven by rising US yields, which are putting significant pressure on Asian currencies. The anticipated weaker Chinese yuan (CNY) fixing, as Chinese policymakers return from holidays to address recent market shifts, is expected to further amplify regional currency weakness.

The Mexican peso (MXN) has already experienced a decline following comments from President-elect Claudia Sheinbaum, highlighting the risks for various currencies as FX traders anticipate Wednesday's US CPI data and the Fed policy decision. These factors, combined with China's upcoming data releases, are likely to increase FX volatility.

Despite these challenges, there is a positive outlook for China's equities. Reports indicate robust growth in domestic tourism spending over the recent three-day holiday, suggesting a potential recovery in domestic demand. However, a sustained revival among consumers will depend on addressing issues in the property sector. Policymakers will need to follow through on their recent announcements to maintain positive sentiment.