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Dollar maintains upward momentum into weekend on fading pivot expectations

Two- and ten-year Treasury yields are climbing and the dollar is outperforming its major rivals as investors (seemingly) begin to buy into the Federal Reserve’s much-repeated “higher for longer” narrative. S&P and Nasdaq futures are setting up for a modest gain at the open, and commodity prices are down, with the West Texas Intermediate benchmark knocking on the $70 threshold once again.

In prepared comments released early this morning, Federal Reserve governor Michelle Bowman said the central bank might be forced to raise rates further as it struggles to slow growth and bring inflation down. Speaking to a banking conference in Germany, Bowman noted that recent data “have not provided consistent evidence that inflation is on a downward path,” warning “Should inflation remain high and the labor market remain tight, additional monetary policy tightening will likely be appropriate to attain a sufficiently restrictive stance of monetary policy to lower inflation over time”.

Numbers released Wednesday showed that – although underlying price pressures are easing nicely and helping support the case for a pause at the Fed’s June meeting – core inflation levels remain well above recent historical norms. And while yesterday’s jump in initial claims for unemployment benefits might foreshadow an imminent softening in employment conditions, virtually every other indicator suggests that labour markets remain unusually tight.

Although rates traders have long been convinced that a Fed pivot is imminent, doubts are beginning to creep in, with some betting that the central bank will deliver another hike in June and hold rates right through to mid-2024. We would consider that unlikely, but expectations for two or more cuts before the end of the year also seem less than realistic, given that policymakers – mostly reared in academic settings that prioritize the lessons of the 70’s – have repeatedly insisted they will maintain rates in restrictive territory until growth has slowed and inflation has shown decisive evidence of reversing back toward pre-pandemic levels. 

The pound is back on the defensive after data showed the economy contracting in March, challenging some of the Bank of England’s recent optimism. According to numbers published by the Office for National Statistics, the British economy eked out a small 0.1-percent gain in the first quarter – beating earlier expectations – but shrank -0.3 percent in March as a number of short-term drivers turned negative.

The University of Michigan’s consumer sentiment index for early May is seen slipping to 63.0 from 63.5, and year-ahead inflation expectations might correct lower after rising from 3.6 to 4.6percent in April. The St. Louis Fed’s James Bullard and Governor Philip Jefferson will speak later in the day (San Francisco’s Mary Daly is also delivering a commencement address, but that form of forward guidance is likely too long-term in nature for markets).

A meeting between President Biden and Congressional leaders that had been scheduled for today was pushed forward into next week, but debt ceiling negotiations are continuing at a staff level. In an interview with Bloomberg television, Treasury Secretary Janet Yellen said it remained difficult to tell when, precisely, the Treasury’s special accounting measures would run out of capacity, but noted that she would provide updates as the deadline approached. Many observers, including ourselves, suspect that another round of market turmoil might be the only way to focus political minds – and that this could be the straw that breaks the post-pandemic recovery’s back. We hope we’re wrong.

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