Daily Market Comment – Dollar mixed amidst increasing chances of a Fed skip

  • The probability of a Fed pause next week rises to 80%
  • Dollar gains the most against euro, loses versus the aussie
  • Investors are split on whether the BoC should hike today
  • Wall Street enjoys another day of gains

Investors more convinced that the Fed will pause

The US dollar traded mixed against the other major currencies on Tuesday, gaining some ground against the euro, the yen, and the Swiss franc, and underperforming versus the aussie, the kiwi and the loonie. The greenback traded virtually unchanged against the pound.

With no major economic releases and events to drive the US currency, investors continued adding to their bets of a potential pause at next week’s FOMC decision, with the probability of no action now resting at 80%. A July hike is not a done deal either, with only 18bps being penciled in, while conditional upon a summer hike, investors are anticipating more than two quarter-point cuts by January.

On Monday, the ISM non-manufacturing PMI pointed to economic stagnation during the month of May, with both the new orders and prices subindices sliding, which came to add to speculation that inflation may slow faster than previously anticipated after the downside revision of the Unit Labor Costs index, the tumble in the ISM manufacturing prices subindex, and the slowdown in average hourly earnings last week.

With all that in mind, the last big test for the US dollar ahead of next Wednesday’s FOMC decision is likely to be Tuesday’s inflation numbers. If the report reveals a slowdown in both headline and core terms, dollar traders may doubt even further whether a summer hike will materialize, which could hurt the dollar. The opposite may be true if the data points to stickier-than-expected prices.

Euro the loser, aussie the winner, loonie awaits the BoC

The euro was the currency that lost the most ground against the dollar yesterday, perhaps after an ECB survey revealed that Eurozone consumers lowered their inflation expectations and as ECB policy maker Klass Knot, an outspoken hawk, said that although inflation pay prove difficult to tame, monetary policy is showing signs of effectiveness and further rate hikes must be done step by step.

Compared to President Lagarde’s more aggressive rhetoric, this appears to be a softer stance, suggesting that not all policymakers are seeing future hikes as set in stone. The market is fully pricing in a hike at the upcoming gathering, while it anticipates another one before officials take the sidelines.

The aussie was the main gainer, rallying after the Reserve Bank of Australia stunned the markets with another 25bps hike and said that further tightening may still be required. Following the RBA decision, the probability of a Bank of Canada hike today went up to 50% from around 30% on Monday.

Therefore, if BoC policymakers decide to stay sidelined, but stick to their guns that they remain prepared to hike more if needed, the loonie is likely to slide but not much. For a sustained tumble, officials may need to signal the end of this tightening crusade. Now, in the case of the Bank pressing the hike button today and appearing willing to deliver more, the loonie could rally.

Wall Street extends rally, risks of a correction increase

Wall Street enjoyed another day of gains, with the Nasdaq once again being the frontrunner. It seems that with the probability of a June pause rising, bets of a July hike being scaled back, and expectations of deep rate cuts next year, investors are more than willing to add to their risk exposure now that the debt-ceiling drama is over.

Nonetheless, the Nasdaq is more than 40% up from its October lows, not posting a decent correction since mid-March. Therefore, the risks of a corrective setback seem to be increasing, especially with a potential liquidity squeeze from Treasury issuance looming.


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