The US dollar was once again broadly stronger last week, ending it modestly higher against most of its major counterparts.
We contested that the move upwards in the greenback in the week previous was likely driven by nothing more than stretched investor positioning and profit taking. The catalysts behind the rally last week were far more clear cut, and a product of both safe-haven flows and receding bets in favour of a policy reversal from the Federal Reserve. For the most part, US data continues to hold up relatively well, while FOMC policymakers strike a hawkish tone that suggest rate cuts are not in the offing any time soon. This allowed the dollar to post gains against all other G10 currencies last week, with the sole exception of the New Zealand dollar.
Negotiations in Washington over an increase in the US debt ceiling, which were described as ‘positive’ over the weekend, have continued to rumble on. An unthinkable US debt default remains possible in early-June. We see this as highly unlikely to come to pass, though the uncertainty is likely to keep low-risk assets well bid this week. Attention among investors in the coming days will also be on a host of major economic data releases, notably the preliminary G3 PMIs for May on Tuesday. We also expect heightened volatility in sterling surrounding this Wednesday’s highly important UK inflation report, which is set to show that price pressures eased sharply in Britain last month.
News out of the UK last week was largely bearish for the pound. For the first time in a long time, we are beginning to see signs of weakness in Britain’s labour market. Nominal earnings growth remains elevated and not far from record highs, though last week’s jobs report showed both an unexpected increase in the jobless rate and a jump in the claimant count, which measures the changes in claims for unemployment benefits. Bank of England governor Bailey acknowledged that there were signs of a cooling in labour market conditions during his communications last week, while noting that UK inflation was set to drop sharply in April. We won’t have to wait long to find out, with the latest CPI report to be released on Wednesday morning. Economists are eyeing a near 2 p.p decline in the headline number to just 8.2% that, if confirmed, could weigh on expectations for UK interest rates and the pound.
The euro was largely at the mercy of sentiment towards the dollar last week, particularly after the latest Euro Area GDP and inflation data came in almost bang in line with estimates. ECB President Lagarde failed to touch on monetary policy during her public appearance last week, although fellow Governing Council member De Guindos argued that there was still scope for the bank to raise rates, even if most of the tightening was already behind us. We are in the midst of a relatively quiet period of economic news out of the common bloc. Tuesday morning’s PMIs will be closely watched for signs of ongoing resilience in business activity, though data other than that is rather scarce. A number of ECB members will be speaking later on Monday, including chief economist Lane. Unlike the Fed, the ECB still has a little way to go before it can call time on its hiking cycle, and we expect policymakers to acknowledge this leading up to the next meeting in June, which is all but certain to yield another 25bp rate increase.
As mentioned, largely strong US economic data, including a drop in jobless claims and rebound in retail sales, and some hawkish comments from Federal Reserve members have kept the dollar well bid in the past week. FOMC chair Powell delivered some rather mixed remarks on Friday. While he appeared to confirm the bank’s plans to pause the tightening cycle at the June meeting, he also seemingly pushed back against market pricing for rate cuts, warning that a failure to bring down inflation would result in further pain for the US economy. Investors have reacted to these largely dovish remarks by dampening their expectations in favour of a Fed policy reversal, with futures now seeing only 45bps of cuts by year-end, down from 80bps a little over a week ago. The latest FOMC meeting minutes will be released on Wednesday evening. Absent any shocking revelations here, we suspect that activity in the dollar may be driven largely by news on the ongoing discussions in Washington.