The correction in the value of the US dollar was short-lived despite the bipartisan deal on the US debt limit.
However, the dollar is still receiving considerable support due to increasing market speculation of a 25-basis point hike by the Federal Reserve in June. This expectation is currently priced in with a 64% implied probability according to the Fed Funds futures curve.
If the Fed decides to pause in June, there is a 98% probability of a hike in July, while the current pricing suggests a decrease of less than 50 basis points before the end of the year.
To potentially alter this hawkish narrative, there are three significant data releases before the Federal Open Market Committee (FOMC) announcement on June 14th. These include the jobs data for May, which will be released on Friday, the ISM services data for May on the following Monday, and the inflation figures for May on June 13th.
Unless there are major negative surprises in these data points, particularly in payrolls and consumer price index (CPI), the dollar is expected to maintain its support leading up to the FOMC announcement as the market solidifies its expectation of a rate hike in June.
Yesterday, the debt limit deal passed a crucial hurdle as it was approved by the US House Rules Committee by a narrow margin of 7-6. The deal is scheduled for a vote in the House of Representatives today. While clearing the committee hurdle was an essential procedural step and both parties claim to have the necessary votes for approval in Congress, the slim margin has caused some nervousness in the markets, which may persist for a few more days.
This uncertainty could be contributing to the current demand for the dollar, although the overall risk-off sentiment seems to be primarily driven by disappointing manufacturing Purchasing Managers’ Index (PMI) data from China.
The official survey revealed a drop to 48.8, indicating contractionary territory and marking the lowest reading since December 2022. Market sentiment regarding Chinese economic growth plays a crucial role in the potential shift from the dollar to European currencies, and the recent slowdown in the Chinese recovery narrative is delaying such a rotation.
In combination with the ongoing re-evaluation of hawkish expectations for the Federal Reserve, I believe the dollar will maintain its gains for the time being.
Among the G10 currencies, the AUD and NZD are the most vulnerable to weak Chinese data. The NZD is the worst-performing currency at the moment and cannot rely on domestic support following the dovish surprise from the Reserve Bank of New Zealand last week.
In Australia, the April inflation numbers exceeded expectations at 6.8% year-on-year, rekindling some expectations of a rate hike by the Reserve Bank of Australia and providing some protection to the AUD against the impact of Chinese data. RBA Governor Philip Lowe emphasized in his recent testimony that the central bank’s decisions are fully dependent on economic data.
Market commentary and analysis from Luca Santos, currency analyst at ACY Securities
