• Powell signals Fed may be done raising rates, pushing June hike odds into reverse
• Dollar takes a tumble but quickly finds its footing
• Stocks also struggle amid ongoing debt ceiling drama as clock keeps ticking

Fed Chair Jerome Powell waded into the policy debate on Friday, adding his much-anticipated view on whether or not the time has come to press the pause button on rate increases. It comes after a week-long barrage of Fed speakers where there seemed to be a clear majority favouring another rate rise in June.

Markets were braced for Powell to endorse one final hike, with many investors forced to reassess their pause bets, but that didn’t happen. Powell took the markets completely by surprise, steering the debate firmly in the direction of a pause just as several of his colleagues had flagged the possibility of more tightening.

Citing the uncertainty about the lagged effects from both the rate hikes to date and the credit tightening from the banking stress, Powell said “we can afford to look at the data and the evolving outlook to make careful assessments”, in his clearest signal yet that the Fed is about to enter a wait and see period.

Rate hike expectations for the June 14 policy decision were quickly scaled back, having risen sharply in the preceding days, though investors are still pricing about 16%-17% probability of a 25-basis-point move. But what’s more striking is that market expectations for rate cuts for the second half of 2023 only went up slightly after Powell’s remarks.

Although Powell may have set the stage for a showdown with other FOMC members at the June meeting, where the likelihood of a split vote is looking high, he may be trying to win over the hawks by suggesting that any pause would be conditional.

Should Powell keep the door wide open to further tightening at some point after June, this may not only secure him a unanimous vote, but it would also send the markets a clear message that the Fed has no intention of cutting rates this year.

This is probably why the market reaction to his unexpectedly dovish stance was somewhat subdued. Treasury yields continued to climb on Friday and have only fallen back today. The US dollar slid the most against the yen and risk-sensitive currencies but retreated more modestly against European currencies. It was trading only marginally lower on Monday.

The aussie and kiwi are likely benefiting from hopes that the strained ties between Washington and Beijing might be thawing after President Biden told reporters at the G7 summit in Japan that he expects relations with China to improve “very shortly”.

The euro and pound were attempting to extend their gains today, but it may be difficult for the two currencies to generate much momentum ahead of tomorrow’s flash PMI readings for May.

On Wall Street, all three main indices closed lower on Friday, although the S&P 500 and Nasdaq still managed to end the week with solid gains.

Uncertainty about the debt ceiling is starting to unnerve traders as the June 1 deadline approaches. The White House and congressional leaders have just days to reach a deal on raising the debt limit as any agreement would take time to get through the two chambers of Congress.

Negotiations between Republicans and Democrats were cut short on Friday as temperatures over disagreements soared. But talks resumed on Sunday, with Republican House Speaker Kevin McCarthy describing them as “very productive”. Biden is set to meet with McCarthy later today.

US futures were trading flat ahead of those crucial talks, while European stocks were mixed.