Market Brief: Dollar Momentum Fades As Rate Cuts Return

The dollar is beginning the new week on a defensive footing after Friday’s non-farm payrolls print helped resuscitate hopes for rate cuts from the Federal Reserve. Treasury yields are flat, North American equity bourses are pointing to a supportive open, and currency markets are seeing a second day of broad-based risk-taking.

The April jobs report showed labour market conditions easing, but remaining extremely tight. Employers added 175,000 positions, down from an upwardly-revised 315,000-job print in the prior month. The unemployment rate rose an almost indiscernible 0.03 percent, climbing from 3.83 to 3.86 percent, and marking the 27th consecutive month below 4 percent - matching the longest period since the sixties. Perhaps most importantly for Fed policy, average hourly earnings rose just 0.2 percent, bringing the three-month annualised increase to 2.8 percent, down sharply from 4 percent in March.

Swap markets are now pointing to two rate cuts in 2024, down from seven in early January, but up from the single move priced in last Tuesday. Two-year yields are holding near 4.8 percent after briefly breaking through the 5 percent threshold at the end of April. Dollar index-weighted rate differentials are still heavily tilted in the greenback’s favour, but are coming down off their highs as the balance of economic surprises turns negative.

The euro is holding in the mid 1.07’s against the dollar after failing to sustain Friday’s break above 1.08. With inflation gradually grinding toward target, the European Central Bank set to begin lowering borrowing costs in June, and gross domestic product data pointing to a modest recovery, growth expectations are ratcheting higher.

British pound traders are treading cautiously ahead of this Thursday’s Bank of England decision, with event risks becoming more balanced as the countdown continues. The island nation’s economy has shown signs of life in recent months, improving in line with a rise in real household incomes, and rate cut expectations have undergone a dramatic reversal. But price pressures continue to subside, and policymakers seem likely to express growing confidence in the disinflationary outlook. A shift in the balance of opinion on the Monetary Policy Committee also seems possible, with at least one additional member joining Swati Dhingra in voting for a rate cut.

Canada’s loonie traded higher on Friday as a softer US payrolls report helped lower background borrowing costs, but the exchange rate has suffered serious damage in recent months as weaker data has translated into a divergence between Fed and Bank of Canada rate expectations. We think this dynamic may have peaked in late April, with rate differentials now poised to narrow as US data loses momentum relative to Canada’s. Canada’s economy is hardly in the clear - household debt burdens are set to climb further in the years ahead - but expectations for the US look quite overheated. If Friday’s Canadian jobs numbers come in hot, a modest bout of outperformance could be in the offing.

Data out this afternoon could show US lenders continued to tighten credit standards in the first quarter, helping offset a loosening in market-based financial conditions. If the Fed’s Senior Loan Officer Opinion Survey shows loan growth slowing as banks face higher borrowing costs and rising default rates - reducing the flow of cash into the economy - markets could join Jerome Powell in expressing more cautious views on the growth outlook.

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