The dollar is climbing this morning, ostensibly benefitting from safe haven flows as the political theatre surrounding the debt ceiling negotiations reaches a higher pitch. But with President Biden poised to return early from the G7 summit in Japan and House Speaker McCarthy saying “It is possible to get a deal by the end of the week. It’s not that difficult to get to an agreement,” we suspect other forces are in play.

Yesterday’s retail sales report – which showed underlying US consumer demand remaining surprisingly robust for a third consecutive month – may be triggering a broader rethink on the Federal Reserve’s expected rate trajectory. Recent data suggests that a boom in home refinancing activity during the pandemic freed up almost half a trillion in equity and lowered borrowing costs for many households, which – when paired with another half trillion in remaining excess savings – could fuel stronger-than-expected spending for months to come and keep the central bank on a tighter footing for longer.

In a series of interviews and speeches through the early part of the week, Fed officials signalled they remained committed to maintaining a tighter policy stance. Atlanta’s Bostic noted he was “inclined” to pause rate hikes at the next meeting, saying the central bank might be “close to overdoing it,” but called cuts “unlikely”. Richmond’s Barkin told Reuters “I wonder whether we’re not going to need more impact on demand to bring inflation down to where we need to go,” and Minneapolis’ Kashkari said “we have more work to do on our end, to try to bring inflation back down”. Cleveland’s Mester outlined a still-hawkish bias and said “I need to see more evidence that inflation is still moving down. I think that we just have to stick with what we’re doing”. Odds on a hike at the June meeting crept higher, and are nearing the 30-percent mark as we go to pixels.

The Japanese yen, which would normally benefit from safe haven demand, remains under pressure, failing to gain momentum from a stronger-than-expected gross domestic product report. According to data released last night, the world’s third largest economy grew by an annualized 1.6 percent in the first quarter, with a solid rebound in domestic demand among businesses and consumers helping to offset weakness in exports. 

The Canadian dollar is weaker against the dollar but is outperforming many of its counterparts as yield differentials narrow in the aftermath of yesterday’s hotter-than-anticipated inflation print.Markets have raised the estimated likelihood of another rate hike from the Bank of Canada in June or July, with overnight index swaps putting roughly one-in-three odds on a move that was considered extremely improbable only weeks ago. Despite widespread pessimism (including from ourselves) employment numbers remain strong, housing activity is in the midst of a remarkable rebound, and card spending data suggests consumers haven’t yet begun tightening their purse strings. In a speech last week, Governor Tiff Macklem said “If we start to see signs that inflation is likely to get stuck materially above our 2-percent target, we are prepared to raise rates further”.

A much quieter day beckons: US energy inventories will land at 10:30, and a Senate hearing on strengthening Fed accountability is scheduled for 2:30. The next few days are also looking relatively uneventful – the US will publish weekly jobless claims and Mexico will announce its latest rate decision during tomorrow’s session, and Canada will print March retail sales on Friday.