With a long weekend ahead, the dollar looks set to consolidate its biggest weekly advance since early April as markets capitulate in the face of hotter-than-expected US growth data and a more hawkish Federal Reserve. The greenback is down slightly in early trade against all of its major counterparts – other than the yen – but remains roughly half a percent stronger on the week, two-year Treasury yields are up a little more than 2 percent, and equity futures are steadily giving back Wednesday’s gains ahead of the North American open.

Defying our expectations, the US economic activity accelerated in early May to its fastest pace in two years. S&P Global’s latest composite purchasing manager index showed output in the services sector jumping by the most in a year, while manufacturers reported an improvement in production levels for a fourth consecutive month. Input costs rose sharply, with higher staff bills increasing pressure on the services side of the economy, while factories saw the biggest increase in a year and a half, indicating limited passthrough from falling prices in China.

This backdrop could complicate the Federal Reserve’s rate-cutting plans. Minutes from the central bank’s last meeting showed policymakers turning more cautious, noting “While supply chain improvements had supported disinflation for goods prices over the previous year, participants commented that an expected more gradual pace of such improvements could slow progress on inflation”. Officials are growing increasingly uncertain as to whether current policy settings are restrictive enough to slow inflation meaningfully, and many have doubled down on a “higher for longer” message in a series of appearances in recent weeks. A long-standing disconnect between the published estimates of Fed officials – the quarterly summary of economic projections – and swap-implied interest rates has flipped since March, with markets now anticipating less easing than the “dot plot”. We expect this to converge somewhat in early June, with the median number of cuts moving closer to the single move currently priced into markets.

But signs of a worldwide economic upturn are growing impossible to ignore. With the exception of the United Kingdom – where the April print looked unsustainably strong – and Canada, which hasn’t reported yet, purchasing manager indices in most of the major economies have turned upward in recent months, suggesting that an early-year improvement in the global manufacturing cycle is transmuting into a wider recovery. We suspect this is largely down to the drastic easing in financial conditions that accompanied the Fed’s rhetorical pivot late last year, but it is nonetheless notable that the long-feared impact of higher rates is not – yet, at least – exacting a meaningful toll on the world economy. This could translate into weakness in the dollar ahead as investors pursue higher-risk opportunities abroad.

The British pound remains stable and implied volatility measures are reverting lower, suggesting that market participants think the Bank of England will begin easing in August and that Keir Starmer will maintain the fiscal trajectory set out under Rishi Sunak’s government. We note that – judging by currency movements alone – Sunak’s record isn’t terrible. Barring an unforeseen tumble in the coming weeks, he looks set to have presided over a bigger increase in the trade weighted exchange rate than any of his predecessors going back to Blair.

Ahead today: With the Boeing-prone transportation category excluded, the consensus expects US durable goods orders to rise by a modest 0.2 percent in April as retailers replenish inventories, but other data points – particularly yesterday’s purchasing manager survey – suggest that the print could surprise to the upside. Canada is expected to report a small decline in retail sales in March, providing further evidence of weak underlying demand in the economy. US bond markets will close at 2:00, and remain shut through to Tuesday morning in observance of the Memorial Day holiday.

The economic data tempo will pick up considerably next week, and volatility could rise as interest rate expectations shift. Euro area inflation numbers for April might help determine the likely pace of interest rate cuts subsequent to the European Central Bank’s well-telegraphed June move, with services prices coming in for particular scrutiny. Producer and consumer price data already released suggest that the Fed’s preferred inflation measure – the core personal consumption expenditures index – could cool to its slowest pace this year, dropping to a rounded 0.2-percent monthly gain from 0.3 percent in the previous month. And the Canadian economy could see momentum pick up slightly, with a preliminary estimate for April gross domestic product inching incrementally higher after flatlining in the prior month.

Plumbing issues could also introduce some short term turbulence. On Tuesday, the US financial system is set to follow new rules imposed by the Securities and Exchange Commission that are designed to shorten the standard settlement cycle for securities transactions – from two business days after the trade date to one. The move will effectively shorten the time-frame under which non-US investors must deliver cash in the transaction process, and could lead to more foreign exchange trades happening in the early evening, between 5:00 and 7:00 pm Eastern, when Asian desks have yet to open and low liquidity gives rise to “flash crash” dynamics. We don’t have any unique insight into whether the financial system is prepared for this – given the long preparation time, it could be a nothingburger, much like the “Y2K” panic – but the risk of outsized moves is certainly real as the transition unfolds.