Weekly Market Update 8 May – Dollar weakened upon possible pausing in the Fed’s aggressive tightening regime

Weekly Market Update 8 May – Dollar weakened upon possible pausing in the Fed’s aggressive tightening regime

1. Dollar weakened upon possible pausing in the Fed’s aggressive tightening regime.  The dollar index slipped from 101.7 to 101.3 during the week. As market expected, the Federal Reserve raised interest rates by a quarter percentage point, bringing the Federal Fund Rate to a range of 5%-5.25%. A key highlight within the FOMC statement on Thursday is about the possible pause in the Fed’s future, as the current tightening of credit within the economy could serve as an extension of a rate hike. However, the Fed continue to emphasise the significance of new economic data, pertaining to inflationary pressures, in their decision-making. JOLTs jobs opening data, measure of labour demand, came out weaker than forecasted on Tuesday, coming in at 9.59M than the forecasted 9.77M. This figure has dropped by 1.6 million since December, suggesting some softening in the labour market that could aid the Federal Reserve’s fight against inflation. However, Nonfarm payrolls increased 253K , beating forecasts of 180K, after a downwardly revised 165K in March. Also, the unemployment rate fell back to a multi-decade low of 3.4%. This underscores the resilience of labour demand despite the gloomy economic outlook in US. Hence, the narrative of a fed pause took precedence, causing weakness in the dollar. CPI and PPI figures are expected this week, and the Fed will be keeping a careful eye on both. Markets expect that PPI m/m will rise to 0.3% and that CPI y/y will remain unchanged at 5.0%.

2. The Euro remained flat against the dollar as it ended the week at $1.10, as markets remain conflicted on ECB’s future interest rate decisions. As revealed on Tuesday, Euro zone core inflation slows in April, down to 5.6% from 5.7%. Consequently, headline inflation came in at 7% as estimated. The price of processed foods, alcohol, and tobacco decreased, and the cost of energy decreased as a result of the mild winter weather. These factors all contributed to an easing in core inflation. The ECB slowed the pace of its interest rate increases when a 25bp hike was announced. Although ECB President, Christine Lagarde, made it clear that there will not be a pause in rate hike, markets are still skeptical as further rate hikes will damage Euro zone’s already weakening economy. Furthermore, recent euro zone banking data showed the biggest drop in demand for loans in over a decade as banks were tightening access to credit. Therefore, increasing rates could escalate the economy into a credit crunch and cause further harm on economic growth. These conflicting economic conditions caused market indecision, which is what led to the flat price action in the Euro against the Dollar. Markets are expecting the release of Final CPI m/m data for Germany and France this week in order to gain insight into the ECB’s upcoming rate decisions.

3. The pound sterling climbed to $1.26 against the dollar, upon strong PMI economic data. The Services PMI was revised higher to 55.9, higher than 54.9 as forecasted. Stronger consumer spending boosted overall business sentiments and business activity within the travel, tourism, and leisure sub-sectors. The Construction PMI edged higher to 51.1 than 50.9 as forecasted, marking a third consecutive increase in construction activity. Rising volumes of commercial work and civil engineering activity helped to offset the steepest decline in residential construction output since May 2020. Markets can look forward to BoE’s monetary policy statement this week. With inflation at persistently high levels, markets are expecting a 92% probability on a 25bp increase in bank rate to 4.5%. 

4. The commodity currencies strengthened against the dollar. Beside the general weakness in dollar, there were significant economic data which strengthened the commodities currencies. Loonie strengthened against the dollar, reaching $1.34. For April, Canada posted a trade surplus of CAD 0.97 billion, above market forecasts of CAD 0.20 billion. Furthermore, non-farm employment changes exceeded expectations, having gained a net 41.4K jobs in April, while the unemployment rate remained low at 5.0%. BoC supports a prolonged, high interest rate environment to overcome sticky wage inflation due to tight labour markets. Aussie climbed against the dollar, reaching $0.68. Despite data on cooling inflation last week, the RBA surprised markets as they increased its cash rate by 25bps to 3.85%, the highest level since April 2012. Australia’s central bank signalled further policy tightening ahead to curb sticky services and energy price inflation, giving strength to the Aussie. Kiwi soared against the dollar, reaching $0.63. The unemployment rate in New Zealand remained unchanged at 3.4% in Q1 of 2023, below forecasts of 3.5%. Q1 Employment Change data showed upside of 0.8% , greater than market forecast of 0.4%. RBNZ Governor Orr emphasized on Wednesday that the capital and liquidity levels of the New Zealand banking system are solid and well-positioned to withstand a scenario with higher interest rates. Though, he notes the damaging effects of high borrowing rates on their farming industry, which accounts for about 5.5% of GDP. Overall, a tight labour market and hawkishness from Governor Orr fuelled the kiwi’s gain. A survey of inflation expectations within New Zealand is due this Friday, which could be crucial as it can influence future interest rate decisions.

5. Brent crude slid to $75 per barrel due to heightened volatility over the global market for oil. China’s factory activity unexpectedly contracted in April as orders fell and revealed poor domestic demand. The Caixin manufacturing PMI contracted to 49.5 in April, hinting at a slowdown in global oil demand. Furthermore, US economic data signalled a persistently tight labour market, driving the narrative of future rate hikes. Higher interest rates could tip the global economy into recession, thereby hurting energy demand. Markets can now look ahead to the US EIA’s short-term outlook report on Tuesday and OPEC’s monthly outlook report on Thursday for guidance on oil prices in the short run. Gold ended the week positive at $2,014 an ounce. Upon announcement of a possible pause in rate hikes, gold reached record-highs at $2,078. Following that, gold dipped slightly after strong employment data within the US. Furthermore, gold demand from central banks fell to 228.4 tons in the first quarter, down 40% from the preceding three months, according to a report from the World Gold Council. Markets can look forward to US consumer inflation data on this Wednesday for direction on gold prices.