The dollar maintained its six-month highs against the yen and seven-week highs against the euro on Friday. This was driven by increasing optimism surrounding the U.S. debt ceiling negotiations and positive economic indicators, which reduced the likelihood of multiple rate cuts by the Federal Reserve this year.
Positive Progress in U.S. Debt Talks
Negotiators from Joe Biden’s Democrats conveyed to the president on Friday that they were steadily making progress in discussions with Republicans to avert a U.S. default. This development came shortly after Biden and top U.S. congressional Republican Kevin McCarthy emphasized their commitment to reaching an agreement to raise the government’s $31.4 trillion debt ceiling. The easing of concerns regarding a potentially catastrophic default led to a revision in market expectations for U.S. interest rates.
Robust Economic Data Fuels Expectations
In addition to the positive developments in debt talks, robust economic data, such as a larger-than-expected decline in new claims for unemployment benefits, suggested a tight labor market. These indications raised expectations that the Federal Reserve might raise interest rates again in the coming month as a measure to curb inflation.
Dollar Index Reaches Two-Month High
The dollar index reached its highest level in two months, experiencing a nearly 2.5% increase over the past two weeks alone. Investors rushed to reassess their predictions regarding the Federal Reserve’s next moves. The hawkish tone communicated by the Fed contrasted with market expectations, prompting a reconciliation process. Fiona Cincotta, a strategist at City Index, stated that the foreign exchange (FX) market was beginning to reflect this adjustment. Notably, the market has now priced in a 40% chance of a rate hike in June, a significant rise from the previous week’s 15%.
Reduced Expectations of Rate Cuts
Two Federal Reserve policymakers remarked on Thursday that U.S. inflation did not appear to be cooling quickly enough to warrant a pause in the tightening campaign. Consequently, money markets indicate that traders now anticipate U.S. rates to decrease to approximately 4.86% by the end of the year, compared to the previous expectation of 4.25% just two weeks earlier. This shift signifies the diminishing likelihood of multiple rate cuts by the Federal Reserve.
FX Market Performance
Although the dollar retreated slightly on Friday, it maintained its firm position. Against the yen, the dollar declined by 0.4% to 138.19 yen, following its earlier six-month peak of 138.745 yen. The euro remained flat at $1.0773, hovering near its lowest level in seven weeks. Similarly, the pound weakened by 0.1% to $1.239, marking its lowest value in a month. The pound’s decline against the dollar in May can be attributed to diverging interest rate expectations between the United Kingdom and the United States.
Positive Sentiment for Australian and New Zealand Dollars
Among other major currencies, the Australian dollar gained some strength from the rise in commodity prices, particularly copper and iron ore. The Aussie appreciated by 0.3% to $0.6644. Meanwhile, the New Zealand dollar also saw a 0.7% increase, reaching $0.6258.
Yuan Depreciates Amidst Sluggish Chinese Economy
The Chinese yuan depreciated to its lowest level since December, reaching 7.0365 per dollar. This decline was driven by disappointing activity data, which highlighted a faltering recovery in the world’s second-largest economy. Currency strategist Christopher Wong from OCBC noted that the yuan’s depreciation gained momentum after breaching the 7.00 mark, with limited resistance from policymakers against the rapid decline.
Conclusion-
the dollar maintained its strength against the yen and euro due to positive developments in U.S. debt ceiling negotiations and encouraging economic data. The dollar index reached a two-month high, reflecting a shift in market expectations regarding the Federal Reserve’s future actions. Other major currencies experienced mixed performance, with the Australian and New Zealand dollars benefiting from increased commodity prices, while the Chinese yuan depreciated amidst concerns over the sluggish Chinese economy.
