Market Briefing: Dollar Surges Higher as Selloff Accelerates

Financial markets are enduring across-the-board selling pressure this morning, with bond yields spiking upward, equity futures headed for a sharp drop, and the dollar steamrolling its major rivals in the advanced and emerging economies alike. Monetary tightening expectations are ratcheting higher after Friday’s hotter-than-expected May inflation print was followed by a rise in the University of Michigan’s price expectations measure, and the trade-weighted greenback is pushing toward cycle peaks. 

Odds on a 75-basis point move at Wednesday’s Federal Reserve meeting have surged above the 25 percent threshold and traders are expecting a hard-hitting policy update. The accompanying economic projections are likely to include a downgrade in growth and employment levels, a rise in inflation estimates, and an increase in policy rate forecasts. 

Investors are increasingly convinced that the Fed will be forced to tighten until something breaks in the real economy. The yield curve inverted briefly last night before recovering somewhat, with the 2-year rate sitting at 3.20 percent and the 10-year a mere 4 basis points higher as we went to print. 

But Fed officials may find it difficult to “outhawk” expectations, and - if recent decisions are any indication - the post-announcement reaction could see the dollar give up some of its gains. 

Spreads are widening in Europe, with peripheral yields rising sharply after the European Central Bank opted not to create a new “anti-fragmentation” mechanism at Thursday’s meeting. The common currency has reversed its gains and is again tumbling toward parity with the dollar. 

The British pound is lower after first quarter gross domestic product and production numbers came in weaker than expected. Most market participants expect the Bank of England to hike rates by another quarter percentage point on Thursday, but a small contingent are looking for a more aggressive move. 

Intervention talk is rising in Japan, but veterans aren’t convinced policymakers are willing or able to do what it takes to reverse the yen’s decline. Unilateral currency intervention has historically had a poor record of success, and changes in the country’s monetary policy settings are expected to lag other major economies for years to come. The currency briefly broke through critical psychological resistance at the 135 mark to trade near a 24-year low, but is now rising as investors unwind yen-funded carry trades. 

The Canadian dollar has dropped to a two-and-a-half week low, hammered by falling crude prices and an overwhelming flight to safety. Implied volatility levels are rising, suggesting that traders expect commodity-linked currencies to suffer more turmoil in the weeks to come as China fights Covid-19, the global economic outlook darkens and financial conditions tighten. 

Happy Monday, stay safe out there!