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Dollar weakens after Fed and ECB decisions match market expectations

The dollar is retreating for a third session, with all of its major counterparts recording gains on a Federal Reserve-driven drop in Treasury yields. 

Oil prices are recovering after experiencing something resembling a flash crash around the Asia open last night, with prices plunging more than 7 percent. The move, which seemed to lack a fundamental trigger, saw closely-correlated currencies like the Canadian dollar and Norwegian krone remain relatively unmoved, but left the West Texas and Brent benchmarks down roughly 15 percent year to date. The market has been hammered by a weakening demand outlook even as the OPEC+ group of exporters has continued its efforts to stabilize prices.

Overall market sentiment looks fragile, with regional bank shares coming under renewed pressure after PacWest Bancorp said it was exploring strategic options with potential partners and investors. The bank, which has been coming under sustained attack from short-sellers, was about eight times smaller than Silicon Valley Bank at the end of 2022 – but does represent the latest in a long line of dominoes to fall as the Federal Reserve’s tightening efforts knock over regional lenders with business models reliant on cheap liquidity.

Although the dust is still settling after yesterday’s Fed decision and press conference, it looks as if policymakers managed to achieve the holy grail in central bank communications – telegraphing an imminent pause in rate hikes while avoiding a profound loosening in financial conditions by convincing markets that at least one more move is possible.

The official statement was changed in ways that many had predicted: a critical reference to “further tightening” was removed, and talk of monetary loosening was strictly avoided. Yields firmed during the early part of the post-decision press conference when Chair Powell said “I think that policy is tight,” before saying, “we are prepared to do more if greater monetary policy restraint is warranted”. But this was partially offset later when, in response to a question about what might prompt rate cuts, Chair Powell said that the rate-setting committee has “a view that inflation is going to come down not so quickly. It will take some time, and in that world, if that forecast is broadly right, it would not be appropriate to cut rates and we won’t cut rates”.

For many market participants, this one-two punch lifted the likelihood of a rate hike at the June meeting, while also signalling an openness to cutting rates if the economy does not evolve as forecast in the latter half of the year. Shorter-duration yields moved up while the long end came down, tilting overall rate differentials against the dollar.

The European Central Bank followed suit in slowing the pace of rate increases at this morning’s decision, announcing a quarter-point hike in its key benchmarks and saying “The inflation outlook continues to be too high for too long”. Policymakers said “Headline inflation has declined over recent months, but underlying price pressures remain strong,” but acknowledged strain in the financial system, warning that “the past rate increases are being transmitted forcefully to euro area financing and monetary conditions, while the lags and strength of transmission to the real economy remain uncertain”. The euro slipped slightly as expectations for further moves were trimmed modestly.

The number of initial claims for jobless benefits is seen ticking slightly higherto 236,000 in the week ended April 29, up from 230,000 in the prior week. The trade deficit may improve, narrowing to $63 billion in March after hitting $70.5 billion in February. And US labor productivity is expected to fall at a 1.9-percent annualized pace in the first quarter. Tomorrow will bring critically-important jobs numbers in the US and Canada, with investors bracing for a modest cooldown in labour markets on both sides of the 49th Parallel.

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