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Dollar Steadies As Rate Cut Consensus Falters

Markets look set for a consolidative session as North American traders return to their desks after a long weekend. Equity futures are pointing to a modestly-negative open, ten-year Treasuries are yielding 4.27 percent, slightly below Friday’s close, and most major currency pairs are settling into ranges established earlier in the month. 

The dollar is up almost 2.5 percent on a year-to-date basis after last week’s higher-than-expected consumer and producer price releases triggered a crisis of confidence among investors who had been betting on an imminent and inexorable easing cycle from the Federal Reserve. Overnight index swaps are pointing to 90 basis points in rate cuts this year, down from the almost 160 points expected in December, and some participants are turning to options markets to hedge against the possibility that rates remain unchanged through the end of the year. Former US Treasury Secretary Larry Summers – admittedly not known to be a particularly good trader – last week warned Bloomberg “There’s a meaningful chance – maybe it’s 15 percent – that the next move is going to be upwards in rates, not downwards”. 

The Chinese renminbi is trading at a four-month low after the People’s Bank of China surprised markets with an unexpectedly-large reduction in borrowing rates. Surprising most market participants, the central bank cut the five-year loan prime rate, which helps determine household mortgage rates, by 25 basis points in the biggest move since the benchmark assumed its importance in 2019. The move helped tilt rate differentials further against the currency, and appears to have underwhelmed onshore investors – stock indices fell on the news – but does signal a deeper commitment to boosting consumer demand. 

Japan’s yen is still pinned near the 150 threshold against the dollar, trading with a distinct defensive bias for a fifth consecutive session. With the economy mired in a “technical” recession and key inflation indicators pointing down ahead of the annual Shunto wage negotiations, market participants have grown increasingly skeptical on the scope of any move into positive rates territory from the Bank of Japan. But official jawboning efforts have grown in volume and frequency: Vice Minister Masato Kanda put traders on notice last week, saying “Authorities are ready to respond 24 hours a day, 365 days a year,” and finance minister Shunichi Suzuki yesterday warned that he was “closely watching FX moves with a high sense of urgency”. We don’t believe policymakers have drawn an arbitrary “line in the sand” around a specific exchange rate, but a sustained rise in volatility could easily spur renewed intervention. 

European yields are holding firm after the European Central Bank released a report showing annual negotiated-wage growth slowing, but remaining elevated at 4.5 percent in the fourth quarter of 2023, down from 4.7 percent in the three months prior. President Christine Lagarde has repeatedly emphasized the role pay gains could play in keeping inflation hotter than desired, and markets see the data keeping officials on a more cautious footing until June, at the earliest. The common currency is clawing its way back from last week’s losses, clinging to the 1.08 level against the dollar as we go to print. 

Stubbornness in Canada’s core inflation measures – out in less than half an hour – would align with signs of slowing disinflation in other major economies, and might further reduce odds on a cut at the Bank’s June meeting. An unexpected softening, on the other hand, could point to idiosyncratic weakness in the Canadian economy, helping bring the projected rate trajectory into closer alignment with the Fed. 
Today’s US data calendar is light, but minutes taken during the Fed’s February meeting, due for release tomorrow afternoon, could impact rate expectations across the front end of the curve. The greenback might add to its gains if officials express more confidence in the economic outlook and downplay the need to cut rates into accommodative territory – something that seems increasingly reasonable, given continued outperformance in labour markets and the broader economy. 

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