Global FX: Bearish EUR factors intensify, USD decouples from real rates, and an update on low FX vols

Hello, and welcome to this week's At Any Rate podcast. My name is Pat Locke. Joining me today this week are the co-heads of FX Strategy, Miro Chandan out of London, Arindam Sandilya out of Singapore, and also our senior ball strat, Vladislav Yankovic joining me from New York.

Look, reasonably important week. Another week, obviously, of optimism on the Iran front, but it looks like there is some material progress towards at least some memorandum understanding here. You know, the dollar sold off as one would have expected and as we've been expecting, but, and obviously it hasn't been completed yet, but it does strike me that the dollar move was, you know, reasonably modest.

I think that is consistent with our bias that, you know, things have improved on the dollar front in general. We turned more obviously constructive a couple of weeks ago, particularly by euro dollar and dollar CAD. We'll talk more about that this week, you know, but certainly the dollar sell-off didn't look, you know, altogether particularly remarkable.

I think that's encouraging from the more constructive dollar side of things. There were some other kind of like local market moving events this week. It seems like most notably, RBNZ was a little bit more hawkish than expected.

We've brought forward our expectations for hikes. We're still looking for a hundred basis points, but now starting in July, Huey has outperformed on the week, on the back of that. You know, looking forward though, you know, part of the reason we've become more constructive on the dollar is this kind of renewed low-level nascent US exceptionalism is how I might describe it.

That will run into another test next week around payrolls following this week's maybe a little bit softer than expected suite of PCE data. But, you know, we've noted for a while that generally the dollar has tracked indicators of labor market momentum here in the US. So a third consecutive beat versus expectations next week, I think would be, you know, material and would give this kind of US exceptionalism idea a shot in the arm to continue into the summer.

So that will be kind of like the feature for us next week. And that's especially the case given that obviously the Fed is turning increasingly hawkish when you look across different metrics of Fed speak and the June FOMC obviously looms large with Kevin Warsh sitting for his first meeting as chair. More broadly, at this point, I'd say it's a little bit surprising that the dollar is not yet stronger at this juncture.

Maybe it has to do with questions about the Fed but, you know, something we explore this week in our publication is that the dollar is looking about, you know, maybe 2% cheap to the recent move up in real yields in the US. A bit of a conundrum there, but maybe to help kind of unpack that and talking about why we think, you know, the euro dollar is still projected to go down. Maybe Mir, I'll bring you in.

You're increasingly convicted on euro dollar down. It sounds like you've been describing it more as kind of entrenched forward-looking weakness for the euro. So what are you seeing on your side and where do you think euro goes from here?

Sure. Thanks, Patrick. And I like how you set this up.

I mean, it is looking like shades of US exceptionalism are coming back. And, you know, as you noted, we have become, I think, at least in sentiment and even in terms of, you know, how we're expressing things a lot more constructive on the dollar. I think the euro dollar, you know, the pair, and from the European side of the equation, quite a few things stand out.

I mean, if you look at the PMIs, for example, last week, we saw a pretty big divergence between Europe and the US. The European numbers are showing some stagflationary pressure. So it's like output measures down, price measures up.

Our economic activity surprise indices have been negative for two and a half months, while US is more in the neutral to maybe slightly positive. And so if you look at the, if you take a step back and you say, OK, fine, what's actually happened to the European growth outlook? Our economists have actually marked down the growth outlook for the seventh consecutive time in the last three months for the eurozone.

So that's, I think that's a pretty big turnaround from where we were for most of the year prior to that, after the German fiscal announcement. And I do think, you know, that that the weakness is getting more entrenched. And of course, you know, my expectation had been if we get a resolution on Iran-US, you know, euro dollar can be a couple of percent higher on that.

And then and then we'd want to fade it. But given this weakness, you know, I do wonder if you're even going to get that pop. The other thing, as you said, is that the relative real rate pricing has moved in favor of the dollar.

Real rates in the U.S. have gone up versus Europe. So if I look at our short term fair value models, you know, the number that it was putting on euro dollar fair value was between 106 to 114 in the middle of the week. That's gone up to 108, 114.

But I think regardless of the measures you're looking at and the horizon you're looking at, we're basically, you know, fair value on a short term basis for euro dollar is below where current spot is. So, you know, to me, from a macro perspective, it just doesn't compute that euro dollar hasn't really broken out of its Jan-Feb range. Even though you've seen a 40, 45 percent increase in Brent and gas prices, you've seen pretty substantive, almost 50 basis point sort of narrowing in the real yield differentials between Europe and the U.S.

So I do think more needs to be priced in. But to your point, you know, there are probably reasons why investors want to keep positioning right and light and, you know, we're going into pretty active sort of almost binary events with the payrolls and the first watch or watch meeting as well in the coming weeks. So maybe that has something to do with it.

But underlying dynamics are certainly turning quite a bit more bearish on euro dollar. Yeah. Thanks, Meera.

You know, I continue to look back to the French PMIs last week, which were just terrible. And that was kind of confirmed today in the first quarter GDP print for France, which contracted not unexpectedly. And similarly, on the real rate side, you know, I have dollar CAD pegged up around 141, 141.50.

So definitely think there's room for this dollar move to extend on that basis. Thanks for that. Arindam, coming over to you in Asia, a question that I get frequently on the Asia side lately is just, you know, how do you explain what's going on in dollar Korea?

I think a lot of people have been very constructive on Korea's prospects, but kind of long and wrong. So how are you thinking about that? And then against that backdrop on the back of the dollar sell off yesterday, we had a new low in the dollar CNY fix.

What are you seeing? What's the latest on CNY, especially given kind of the view on what we're looking for in euro dollar? Hi, Pat.

So it's a bit of a mixed bag in North Asia. I'd say dollar Korea is lower than where it was at this time last week. But rallies in the warm just won't sustain against the backdrop of another 8 percent up week in the KOSPI, you know, just another regular week for Korean stocks.

I know the news this week was that South Korea's NPS, the National Pension Service, has raised its N26 domestic stock allocation target to 20.8 percent, used to be 14.9. So what that means is it implies less need for the NPS to sell domestic stocks for rebalancing purposes just because of price rallies alone. Right.

So this is a dynamic, I think, that is at the heart of what we're seeing in terms of one weakness, even as Korean equities surge and the AI stories, all the rage, is because most foreign investors have these single stock concentration limits. And literally two stocks in the Korean index are powering almost all of the surge in the index that we're seeing. So every day that you have these big rallies in these two stocks, you are hitting up against those concentration limits and being forced to sell in order to rebalance your portfolio and remain within your limits.

So this was another week where foreigners sold close to three yards of Korean stocks, brings their YTD selling to an eye-popping 65 yards. To put that in context, we are not through half this year yet, and we have already hit 50 percent of last year's full year South Korean current account surplus. So you have a BOP on paper, which looks constructive, and then you have BOP in real life, which because of these offsetting flows are not nearly as currency positive as they would appear.

There are other things going on in Korean macro and the BOP. So you're having incoming flows from World Government Bond Index with the inclusion, which are generally FX unhedged. You're having the MOF sort of modulate near-term bond issuance to keep fiscal and long-end yield fears at bay.

You're having the central bank come across as considerably more hawkish this week than what the market expected. So our economists at Pennsylvania, 100 basis point rate hiking cycle from 50 earlier, supposed to end six to nine months before what it was earlier, which in any other currency would probably have been a positive story. But the won seems to be in its own world where nothing except these equity flow dynamics matter.

And then for the CNY, where we've had a little more love on our views, you know, it's gratifying to see the fixings continuing to do the right thing. It surprised me with the pace at which it's taken out, one big figure after another. So this week, we are below 682 on the fixings, below 677 on dollar CNY spot.

You know, there was some angst in the market that the fixings might begin to plateau or flatline after the presidential summit, but it hasn't happened. And it could certainly be that the Chinese are continuing to provide some FX concessions to the rest of the world in the face of strained trade relations. You know, the EU-China trade relations in particular are in focus at the moment.

You know, as we speak, I think there is a gathering of EU trade commissioners that is going on in Brussels, reportedly trying to come up with a major crackdown on cheap subsidized imports from China. So it sort of makes sense why FX policy in China is behaving in the way it's doing right now. So as CNY bolts, we are not complaining.

We're staying the course on the view. But you're also conscious that you've had almost a straight line, 6% more blow in dollar CNY since Q2 of last year. Now, the dollar CNY spot versus fixing gap is now 500 bits.

It's very, very wide versus history. Investors generally don't want to add fresh bullish CNY positions when the gap is this large. And spot dollar CNY is extremely dislocated versus bilateral rate differentials.

The extent of that misalignment is almost as large as we saw before the big turnaround in 2022 when the world went on a global rate hiking cycle, right? So there are these things that you're paying attention to. You are conscious that there is a dividend outflow season that comes in China at the end of June.

And then the dollar story, as you laid out at the beginning, may be on the cusp of a turn. The Fed story could be on the cusp of a turn. So we are conscious of these factors that are starting to impinge upon the story in a way that they may not have had for the better part of the past year.

Constructive CNY still, but I think there's an active sort of thought process internally about the best expression of the view. Got it. Thanks very much, Arindam.

And then finally, Lad, let's turn to you. I'm interested to hear just kind of a high level take on the vol landscape and whether you see anything that directionally kind of makes sense that matches kind of the suite of macro views that we've put forth today. Yeah, thanks, Pat.

Yeah. So for the point of the FX vols on the back of this fairly decent sentiment lately, we did see FX vols coming down to below 650, which is really the post-COVID lows. The last time that we've seen the material overcome these kind of levels was in 2019, early 2020.

Now, that said, it does seem that FX vol is not really the only asset class that's been pretty much enjoying this ride lower from the vol aspects. VIX is below 16. The rates vols been compressing.

So from that point, it does seem like we are at the levels that seem kind of fair to those cross-asset views. Can vols sell off more? Basically, the headroom is getting really very, very limited at this stage.

I mean, back in that 2019, 2020, a few months of that soft pocket, vols did reach about one vol below the current levels. But at this point, it seems like, yes, we could get a leg lower, but we're kind of starting to hit levels where realized vol may be kind of starting to hold how far it can go. We are watching some of these locations on the Asia EM, some of the high yielders still, after some of the unbinds we've seen over the last couple of weeks, they still contain some premium.

But really, it's kind of starting to be a little bit of few only of those kinds of pockets. Now, with the current state of the vols, it still remains very, very much support or carry. So yeah, I'm kind of watching pretty closely the developments on the high yielders.

Also, cross yen is kind of interesting in the places like Aussie yen and does seem like at this level of vols, optionalizing those kinds of expressions could be interesting. Beyond that, really, just kind of also keeping my eye on a couple of other places like, for example, UK political risk does contain some of the premiums. So watching there like Euro sterling, for instance, even though now with the potential Iran war deal, then we could see a little bit messier dynamic there, but potentially this elevated skew in euro sterling, which was even before the UK political risk, is something that potentially can be factored in.

And then also things like upcoming USMCA review on July 1st, from a point of directional side, could have some, even though it's low probability at this stage, impact on dollar max and dollar cad. So it is possible to construct some of the efficient expressions, conditional bullishness on the dollar max or dollar cad with some of the other effects like bullish or dollar in order to kind of protect against those things. Bottom line for me is that this low vol levels are helping optional is scary.

And in addition to that, we are watching those pockets of premium like Asia where it could be a little bit more downside on the vol side and basically following some of those idiosyncratic stuff. We did go a little bit more details in our weekly publication. Back to you, Pat.

Yeah. Thanks, Vlad. Certainly from my perspective, Iran is not resolved yet and the market's obviously repricing the Fed fairly aggressively.

The real yield move would all kind of point to, yeah, some tick up in the vol at least from kind of macro side. So sympathetic to where you're coming from. But I think we'll leave it there.

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This episode was recorded on May 29th, 2026.