Summer Is Coming: How the dollar, euro and yen are set up for a volatile June

• Fresh Chinese covid waves and BOJ reluctance to ease may put the yen on top in June.
• Uncertainty about eurozone inflation and the ECB's moves could keep the euro bid.
• Clear indications of peak US inflation could send the dollar tumbling down. 

How will the dollar, euro and yen play out in June? The month when spring makes way to summer in the northern hemisphere is busy with critical central bank decisions and the US Federal Reserve and the European Central Bank. The yen depends less on the Bank of Japan and more on China. 

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1) The Japanese yen has two reasons to rise

The yen may receive a boost from a fresh outbreak of covid in China, which would trigger lockdowns and a rush to the regional safe haven – the yen. Authorities in Beijing continue prioritizing their zealous zero covid policy in curbing the disease, instead of opting to vaccinate the elderly with Western mRNA vaccines. 

The recent lifting of restrictions from Shanghai's factories and Beijing's closed districts came after the world's second-largest economy crushed covid, but at a high cost to its economy and the global one. For President Xi Jinping, this was a vindication of his policies. 

Another reason to favor the yen is that the Bank of Japan may struggle to maintain its policy of holding 10-year Japanese bond yields to a maximum of 0.25%. With rising prices reaching the shores of Japan, the BOJ may opt to print fewer yen and let the currency rise.

2) Euro boom of sorts

Inflation is rising in the eurozone and consumers seem less worried about Russia's war in Ukraine. Europeans are leaping on flights and vacations despite higher costs, boosting even core prices higher and forcing the European Central Bank to act. While ECB President Christine Lagarde signaled a rate hike would only come in July, she could be forced to raise borrowing costs already in June.

Even if that does not happen, the ECB publishes new forecasts, and they will likely show robust inflation and not-too-depressing growth forecasts. Instead of acting early, the Frankfurt-based institution could indicate July's rate hike would be a double-dose 50 bps one – bringing borrowing costs back to zero. Any hawkishness from the usually wary ECB would send the euro higher.

3) Dollar climbing down the mountain

Why would the world's reserve currency lag while the Fed is pursuing aggressive monetary policy? The US is ahead of the world in its economic cycle, and recent indicators have shown that higher prices are already causing some demand destruction. Sales of homes are falling and yearly inflation seems to have peaked. 

While the road back to normal inflation is still long, my bet is that June would be the month in which America sees peak inflation in the rear-view mirror. If the Fed gives the notion that the worst is already behind us, the dollar could begin a more substantial descent. Such a decline would still be gradual, but with fewer countertrends. 

Apart from the Fed decision, inflation figures and home sales are also crucial in defining the dollar's direction. 

Conclusion

Action in financial markets never takes a summer vacation – but just before it becomes too hot, investors tend to act. June is set to be a month of substantial volatility and also long-term changes for currencies.