Investing.com – The U.S. dollar edged higher in European trade Friday, but was on track for a hefty weekly fall after cooling inflation and weak retail sales brought Federal Reserve rate cuts back into focus. 

At 04:10 ET (08:10 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.2% higher at 104.580, marginally above a five-week low just below 104 seen earlier this week.

Dollar steadies after hawkish Fed speak

The dollar has recovered to a degree as several Fed officials, specifically members of the bank’s rate-setting committee, said that they needed much more confidence that inflation was coming down, beyond some easing inflation in April.

“I now believe that it will take longer to reach our 2% goal than I previously thought,” St. Louis Federal Reserve president Loretta Mester said on Thursday, adding that further monitoring of incoming data will be needed. 

Federal Reserve Bank of New York President John Williams agreed with this view. 

“I don’t see any indicators now telling me … there’s a reason to change the stance of monetary policy now, and I don’t expect that, I don’t expect to get that greater confidence that we need to see on inflation progress towards a 2% goal in the very near term,” Williams said.

However, the dollar is still on course for a weekly loss of around 0.7% after the milder than expected U.S. data raised expectations the will deliver two interest rate cuts this year, probably starting in September.

U.S. were also flat in April and softer-than-expected, and manufacturing output unexpectedly fell.

“Our view for the near term remains that we could see a further stabilisation in USD crosses as markets await the next key data input: April core PCE on 31 May,” said analysts at ING, in a note.

Euro slips ahead of CPI release

In Europe, traded 0.1% lower to 1.0860, having traded as high as 1.0895 in the wake of U.S. inflation release, but the single currency is still up around 0.9% on the dollar this week.

The final reading of the is due later in the session, and is expected to show inflation rose by 2.4% on an annual basis in April.

The is widely expected to cut interest rates in June, but traders remain unsure of how many more cuts, if any, the central bank will agree to over the course of the rest of the year.

Traders have priced in 70 basis points of ECB cuts this year – a lot more than the just under 50 bps of easing priced in for the Fed.

fell 0.1% to 1.2658, but is still on track for gains of around 1% this week.

The Bank of England is also expected to cut rates from a 16-year high this summer, but volatility is likely to be limited ahead of the release of key U.K. inflation figures next week.

Yen slips after weak Japanese GDP data

In Asia, rose 0.3% to 155.87, close to breaking above 156, after weaker-than-expected Japanese data for the first quarter. 

traded 0.1% higher at 7.2209, moving back to six-month highs above 7.22 after data earlier Friday showed grew more than expected in April, but growth in slowed sharply, while a decline in Chinese house prices accelerated last month.

By Nell Mackenzie

LONDON (Reuters) – Pressure on Japan to prop up a weak yen may have ebbed, but currency weakness remains a headache for Tokyo.

The yen is down 9.4% against the dollar so far this year, and looks set for a fourth year of declines. That’s created a two-speed economy, with exports and tourism benefiting from a more competitive exchange rate while households and small businesses are squeezed by rising import prices.

Four investment managers shared four ideas on how to trade yen weakness. Their views do not represent recommendations or trading positions, which they cannot reveal for regulatory reasons.

1/ FLORIN COURT CAPITAL

* Diversified systematic asset manager

* Size: $2 billion assets under management (AUM)

* Founded in 2016

* Key trade: Short-Asia currencies ex-Japan

Florin Court CIO Doug Greenig says that instead of playing a weak yen, investors should put on bets against Asia’s emerging market currencies.

“Investors can consider shorting other Asian currencies like the Korean Won or the Thai Baht, where real interest rates are also relatively low versus some other EM currencies,” Court said. “And you don’t directly face the risk of BOJ intervention.”

The Bank of Japan (BOJ) was believed to have intervened twice, on April 29 and May 1, to stabilise a yen that had slumped to 34-year lows around 160 per dollar. It is now around 155.6.

The yen has weakened sharply for clear reasons: real interest rates are much higher outside of Japan.

U.S. rates have been kept high by loose fiscal policy and a robust economy. By contrast, Japan does not have a free hand in raising policy rates, Greenig said.

Japan’s huge public debt pile is 263% of GDP, but the Bank of Japan holds almost half of that, so the situation might be more nuanced than it looks, he said.

2/ AQR CAPITAL MANAGEMENT

* Systematic asset manager

* Size: $108 billion

* Founded in 1998

* Long Japanese stocks

Jonathan Fader, managing director in the Macro Strategies Group at AQR Capital Management, says BOJ intervention complicates matters for yen bears but the key driver of yen weakness remains – accommodative Japanese monetary policy while rates elsewhere are at multi-year highs.

He favours Japanese stocks that benefit from currency weakness.

Fader noted that the tight relationship between the yen and Japanese shares broke down as Tokyo stepped up verbal intervention. But stock tailwinds remained, such as governance improvements and banks benefiting from an end to negative rates.

The BOJ in March delivered its first rate hike in 17 years.

“Should yen volatility calm down, Japanese shares could well resume their outperformance,” said Fader.

Japan’s blue-chip is off record highs hit earlier this year, but is still up some 16% year-to-date.

3/ MOUNT LUCAS MANAGEMENT

* Macroeconomic hedge fund

* Size: $1.5 billion

* Founded in 1986

* Dollar/yen forwards

For David Aspell, partner at Mount Lucas, a large U.S/Japan rate gap means investors will continue to use the yen as a funding currency for carry trades.

One way to play yen weakness is through currency forwards, contracts that allow investors to hedge FX risk, he said.

Buying a dollar/yen one-year forward contract which trades at a discount to current levels means the currency pair would need to weaken over a year to loose money, said Aspell. Investors would gain if there is no change or dollar/yen strengthens.

“Intervention has the best chance of working medium term when it is a genuine surprise and when it is helped along by the fundamentals,” Aspell said.

4/ PINEBRIDGE INVESTMENTS

* Global asset manager

* Size: $168.2 billion

* Independent since 2010

* Buy high quality, investment grade portions in short duration, refinanced U.S. 2024 CLOs

The BOJ has also abandoned yield curve control where it capped long-term interest rates around zero, but said it would keep broadly buying government bonds as before and ramp up purchases if yields rise rapidly.

Since this policy’s 2016 start, Japanese investors sought higher returning investments elsewhere. The plus 5% yields on investment grade tranches (portions) of U.S. collateralized loan obligations (CLOs) drew many.

“Right now as investors in CLOs, they are our competition because they have such a strong demand for U.S. fixed income assets,” Laila Kollmorgen, a PineBridge managing director, adding that what Japanese investors do will determine how Pinebridge invests later in the year.

Now that JGB yields have hit decade highs, this might tempt Japanese investors to bring funds back home.

“We must remain nimble,” Kollmorgen says.

While the typical CLO deal length is eight years, she’d opt for newly reset CLOs in 2024. On these, the deal time has been restarted. She’ll look for an extended three-year reinvestment period, refinanced debt and lender protection against the bonds being paid back in full during the first year.

Investing.com – The U.S. dollar is on track for a hefty weekly fall on renewed dovish hopes for the Federal Reserve, but this selling “looks exaggerated”, according to HSBC.

At 05:25 ET (09:25 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded at 104.640, on course for a weekly loss of around 0.5%, as well as a monthly drop of 1.3%. 

The USD has suffered from a “double whammy” lately, according to analysts at HSBC, in a note dated May 16. 

Softer-than-expected U.S. activity data and the lack of further upside surprises in April inflation data have rejuvenated dovish hopes for the Fed–hitting the USD through the rates channel–and helped spur risk appetite–hurting the USD through the risk appetite channel which has shown recent signs of gaining more traction. 

However, this two-pronged hit to the USD can also play in the opposite direction, the bank added.

After three months of upside surprises, the Fed may need more than one month’s in line inflation data to be confident about inflation moving to target. 

Also, Fed rhetoric arguing for patience might unsettle the market ahead of the June FOMC where new “dots” lie in wait. 

“We look for the USD selling of the last month to stop in the coming weeks, with a bounce possible against those currencies that could deliver a dovish surprise, or which are vulnerable to risk aversion,” the U.K.-based bank said.

HSBC has chosen to express this expected shift in dollar tone against the euro – opening a trade idea to sell at $1.0880, targeting $1.0550, with a stop at $1.1050.

At 05:25 ET, EUR/USD traded at $1.0841, on course for a weekly gain of 0.7% and a monthly increase of 1.9%.

“While ECB rhetoric suggests a June rate cut seems all but certain, we believe the market may be under-pricing the risk that the door will be left open to a follow-up cut in July,” the bank said.