Markets Struggle to Pin Down a Turning Point in US Expansion

The dollar hit a corrective low yesterday following the release of US labor market data:The US Dollar Index (DXY) fell below the 104.40 level, marking a low point in the retracement since the beginning of June, which sparked some buying interest around 103.30 as discussed in the previous article. Breaking below the horizontal low further "solidifies" the correction pattern, so the majority of buyers may now shift their focus to the lower boundary of the channel and start buying the dollar against major counterparts once it reaches that level. This coincides with the key round level of 103 points. Unexpectedly, initial jobless claims rose from 233K to 261K (forecast was 235K), which intensified the sharp decline in the US currency yesterday (the magnitude of the drop exceeded 0.6%). Typically, the release of jobless claims passes unnoticed, even in the case of a surprise, but not this time. This, firstly, indicates an intensified search for a turning point in the trend of US economic expansion in the market and, secondly, reflects the lack of consensus regarding the upcoming FOMC meeting next week. The bond market also showed sensitivity to the report, with the yield on 10-year bonds decreasing by approximately 10 basis points after the release:Next week, we can expect three key events: the US inflation report for May on Tuesday, the FOMC meeting on Wednesday, and the ECB rate decision on Thursday. The consensus for the monthly US inflation is 0.4%, and anything higher could tilt the scales in favor of a hawkish decision by the Federal Reserve. Considering that the market currently prices in about a 33% chance of a rate hike, a reassessment could lead to a significant strengthening of the dollar and a rebound in bond yields, especially since the FOMC meeting follows the next day. The market also assigns a high probability of a 25 basis point rate hike by the ECB, so a bullish outcome for the Euro implies a clear hint from the ECB that it’s not done with tightening. It is worth noting that in the case of the Fed pausing and an uncertain forecast for tightening in July (the market consensus expectation), we may experience a significant decline in the dollar, as historically, after a pause, the Fed had mostly been cutting rates after some time. The case for a rate hike is supported by the labor market (+330K jobs in April), as well as unexpected policy tightening by the Bank of Canada and the Reserve Bank of Australia, which may indicate an underestimation by the market of rebound in global inflation. The case for a decline is supported by comments from top Fed officials suggesting that it may be prudent to get more information about economy’s response to policy tightening.  Among other major reports next week, US retail sales, industrial production, and consumer sentiment from the University of Michigan should be noted.