On Tuesday, the risk-sensitive pound was influenced by renewed global risk aversion as investors sought safety in traditional safe-haven currencies like the US dollar, Japanese yen, and Swiss franc. This shift was triggered by the surprising outcome of India's election, where Narendra Modi lost his parliamentary majority.

Markets had anticipated a landslide victory as predicted by exit polls, but this result highlighted the unreliability of polls. The election outcome was much closer than expected, and the resulting coalition government spurred a wave of demand for safe-haven assets, boosting the Japanese yen. The yen was further supported by hawkish remarks from a Bank of Japan (BoJ) official, who hinted at scaling back bond purchases in the upcoming meeting this month. This led to a bullish shift in yen risk reversals across several tenors, indicating the strongest positive sentiment in weeks. As a result, USD/JPY fell to two-week lows, while GBP/JPY and EUR/JPY experienced their largest daily drops in over a month, with the former falling from ¥200 to nearly ¥197. Although the yen has since given up most of these gains, increasing volatility suggests potential for further strengthening amidst divergent monetary policies and political developments.

These recent political and monetary policy surprises underscore the sensitivity of certain currencies. Significant fluctuations can occur rapidly, especially with the yen. The British pound, also a risk-sensitive currency, is susceptible to substantial swings, particularly periods of weakness during heightened risk aversion. This is crucial to consider with upcoming central bank meetings and elections in Europe, the UK, and the US.

The euro depreciated for the first time since last Wednesday as risk-off safe-haven flows dominated the markets. German unemployment claims unexpectedly rose by 25,000, compared to the anticipated 10,000, while the unemployment rate remained steady at 5.9%. Despite this, investors have reduced their expectations for European Central Bank (ECB) policy easing this year, primarily due to the surprising inflation increases over the past two months. The inflation uptick in May led some policymakers to adopt a more hawkish stance, casting doubt on the likelihood of consecutive rate cuts in July.

Some central bankers, particularly from Germany, appear to have ruled out policy easing at the July meeting. However, ECB pricing still tends to follow the Federal Reserve. This means that a potential downturn in the US economy and the end of US exceptionalism could reintroduce some of the rate cuts that were previously priced out. Despite the recent depreciation, the euro is still on track to appreciate for seven out of the last eight weeks, influenced by last week’s persistent inflation report.

EUR/USD is holding above the $1.0880 level, but momentum will need to be confirmed by today's US ISM PMI data and Thursday’s ECB rate decision. Any significant positioning is likely to be cautious and limited ahead of the US labour market report on Friday.

The US dollar has weakened against most G10 currencies. GBP/USD has reached fresh 12-week highs above $1.28, while EUR/USD has reclaimed $1.09 for the first time since mid-March. This dollar weakness is due to declining yields following the US ISM manufacturing PMI report, which confirmed trends of slowing growth, decelerating inflation, and a tight labour market. Investors are closely monitoring data to assess how long the narrative of US exceptionalism can persist. The nonfarm payrolls report on Friday will be a critical event for cross-asset developments. Yesterday, the US manufacturing PMI surprised markets with a decline from 49.2 to 48.7 in May, impacting the US currency. Notably, the employment category showed improvement after seven months of contraction. JOLTS job openings will be important today, followed by services PMI on Wednesday and the eagerly anticipated jobs report on Friday

The key event this week will be the widely anticipated ECB policy rate decision on Thursday.

GBP fell from 21-month highs against the EUR following Friday’s release of higher-than-expected Eurozone inflation data, disrupting a bullish technical setup and raising the potential for a deeper pullback to £/€ 1.17 or lower at interbank.

The recent strength of GBP has been driven by diminishing expectations for a June rate cut by the Bank of England (BoE). Markets now do not fully anticipate a rate cut by August. In contrast, the European Central Bank (ECB) is expected to cut interest rates this week, creating a clear divergence in monetary policy between the UK and Eurozone that supports GBP gains. Since markets already anticipate an ECB rate cut on Thursday, the actual decision won't be surprising; instead, market movements will be influenced by guidance on future rate cuts.

In addition to central bank actions, economic data will also be in focus this week. China will release Caixin PMI numbers on Monday, Australia will report March-quarter GDP on Wednesday, and the US will build up to Friday’s non-farm payrolls (NFP) report.

Last month, the NFP report missed forecasts for the first time since October, triggering a USD sell-off and leading to the greenback's first monthly decline in 2024.

The US dollar gained mid-week due to rising Treasury yields, buoyed by strong economic data, hawkish remarks from Federal Reserve (Fed) policymakers, and a series of weak bond auctions. However, a sharp reversal in the dollar index occurred on Thursday following downward revisions of Q1 GDP and core Personal Consumption Expenditures (PCE).

US GDP growth for Q1 was revised down to 1.3%, aligning with expectations, primarily because of slower consumer spending, while PCE prices rose slightly less than initially estimated. Additionally, US jobless claims were slightly higher than forecasts and above the 2024 average. Market participants now anticipate only one rate cut by the Fed this year, with a 65% chance of a decrease in November and 83% in December, compared to 61% and 80% respectively before the release of the US economic data. The dollar index fell below 105, erasing the previous day’s gains and mirroring the decline in bond yields.

Currency markets appear to be engaging in range-trading in this low-volatility environment as investors await further economic data to determine when the Fed might begin its easing cycle. Today's release of the monthly PCE report – the Fed’s preferred measure of inflation – is expected to be a pivotal event, likely setting the next significant trend for the dollar. If inflationary pressures from the first quarter persist, the trend could turn upwards.

In other news, Donald Trump was convicted on all 34 counts of falsifying business records in a landmark criminal trial in New York. This marks the first time a former or sitting US president has been convicted of a crime. The verdict comes as Trump campaigns to unseat Joe Biden in the November election. Sentencing is scheduled for July 11; while Trump could face prison, legal experts suggest a fine is more probable. Nonetheless, Trump remains eligible to run for president, as the Constitution does not disqualify convicted criminals from holding the office. However, this outcome poses significant political risks for his campaign.