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Hopes for Fed pause kick dollar lower

Equity futures are climbing, Treasury yields are coming down, and the dollar is pushing lower as investors position ahead of what many expect will become the Federal Reserve’s last rate hike in this tightening cycle. Risk appetite remains diminished after yesterday’s session brought a decline in job openings, a softening in durable goods orders, and evidence of worsening stress in the regional US banking sector – but expectations for more accommodative policy settings later this year are helping support narrowly-held gains across a number of asset classes. 

Rowing against the overall dollar-negative tide, the Australian dollar is gradually giving back some of yesterday’s policy-driven gains, and the Canadian dollar is coming down as oil prices tumble. Last year’s correlation between the loonie and US equities appears to be giving way as global demand forecasts slump, pulling front-month West Texas and Brent prices lower. Odds are rising on a US recession before year end, and hopes for a big rebound in Chinese demand are fading, hurting the prospects for a renewed investment cycle in the Canadian energy sector, while working to weaken the outlook for overall exports.

Later today, the Federal Reserve is expected to signal an imminent pause while delivering its tenth consecutive rate increase. Officials might maintain a relatively hawkish bias in the accompanying statement and press conference, but elements of a more “data dependent” stance should be visible throughout the central bank’s communications strategy – with credit creation slowing and labour markets showing signs of rolling over, the two non-farm payrolls reports and two consumer price index releases due to drop between now and June could paint a very different picture of underlying fundamentals when the central bank meets next. A sentence in the statement that previously said “some additional policy firming may be appropriate” could be replaced with something closer to: “additional policy firming may yet be appropriate”, and another caveat might be added: “The extent and timing of any such firming will depend importantly on the evolution of the outlook for inflation and economic growth”.

Powell will attempt to deliver a similarly-hawkish message during the press conference, but markets are unlikely to take his words at face value.Former Vice Chair Richard Clarida put it best in an interview this morning when he said “The Chair will have his work cut out for him because when the Chair will say ‘pause,’ the markets may hear ‘done.’ And if he says it again, they may hear ‘rate cuts’”.

Tomorrow’s European Central Bank meeting could leave a deeper imprint on currency markets, with consensus expectations currently split between a quarter- and a half-point rate hike. We think a quarter-point move looks more likely, particularly after yesterday’s lending survey, which showed credit demand shrinking at the fastest pace since the 2008 global financial crisis – but numbers released earlier this morning showed unemployment fell to historic lows in March, and yesterday’s inflation data provided more evidence of stubbornly-elevated core inflation pressures. A bigger move cannot be ruled out. The common currency is trading above the 1.1000 mark against the dollar once more, and market positioning retains a clear bullish bias.

Today’s agenda is otherwise quiet. ADP will release its latest estimate for private sector hiring, but a high noise-to-signal ratio should limit any implications for markets. S&P Global and the Institute for Supply Management will publish updates in their services sector indices, with both expected to show modest improvement in April.

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Twists & turns

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