A strong April jobs report put a short term floor under the US dollar as job growth lowers the probability of a Fed pivot on interest rates.

In the first week of May, financial markets were subjected to a whipsaw of information, leaving many observers confused about the near-term direction of the US economy and the dollar. On Wednesday, May 3rd, the Fed raised interest rates by the expected 25 basis points, followed by a press conference in which Chair Powell described current policy as “tight,” and adding "We're closer, or maybe even there," when asked about the end-point of the current tightening cycle. Markets interpreted his remarks as an indication that the Fed would likely pause to assess its policy's impact on the overall economy. The dollar, already down fractionally for the week of Chair Powell's comments, continued its drop toward the low of the year. Two days later came the surprisingly strong monthly US employment report which indicated that new jobs are being created despite interest rates being 5% higher than 14 months ago.

2022 was the year of the dollar as the greenback rallied to multi-decade highs. As occurs in most currency trends, the dollar’s upside momentum took it to levels that left it dramatically overvalued against its Forex peers. At one point, the dollar was worth over 150 Japanese yen, before it began to reverse course. Since September 2022 the dollar(DXY) has lost over 10% of its value against a basket of major currencies. Despite the drop, the dollar remains significantly overvalued by most measures, including purchasing power parity.  Analysts generally expect the dollar to continue its downward trajectory, but unexpected strength in the US economy may lead to another round of dollar appreciation.

Inflation remains Powell’s chief concern. Although inflation has receded from last year’s highs, it has stayed above levels deemed acceptable by the Fed. At last Wednesday’s press conference, Powell stated, "We on the committee have a view that inflation is going to come down not so quickly, it will take some time," he told reporters, and "in that world, if that forecast is broadly right, it would not be appropriate to cut rates" this year. Fed Funds futures markets tell a different story, with expectations for rate cuts priced in by the end of summer. Upcoming data will be the factor that determines which view is correct, so markets will be paying close attention to reports on inflation and jobs over the next few months.

From a technical standpoint, the dollar’s action is very reminiscent of what happened in the first week of February. The Fed raised interest rates on Wednesday, followed by a blockbuster jobs report on Friday. The result was a dollar rally of almost 5% during the next few weeks. 

What Reports to Watch:

• 6/2 - US Employment Report. Slowing job growth would support a Fed pause in rate rises. More jobs, especially with concurrent rising inflation, might force the Fed to raise rates again.
• 6/14 - FOMC. The Fed is expected to leave rates unchanged at this meeting. According to the CME FedWatch tool, there is a 90.4% chance of no change in rates, with a 9.6% chance of a 25 bps increase. In Chair Powell’s words, Fed action will be “data dependent."

News That Could Affect the Dollar:

• More problems in the US banking sector. Many analysts expect regional banks to slow lending activity which could result in a credit crunch. This could broadly impact the economy, including significant job losses, and would be perceived as negative for the dollar. Also, many banks have large commercial real estate loans which are being hit by the double whammy of increased vacancies (work from home effect) and higher interest rates.
• The debt ceiling crisis. A failure to raise the debt limit would have disastrous consequences for the US economy, and could result in a dramatic sell-off for the dollar.
• Geopolitical events. Changes in the situation in Ukraine would have a direct impact on the dollar, particularly against the euro. Any steps to end the conflict would be expected to weaken the dollar, while heightened hostilities could bring a “safe haven” bid to the US currency.

Inflation appears to have peaked. Prices for most commodities have dropped over the past few months, so over time lower prices should work down to the retail level. The S&P Goldman Sachs Commodity Index is currently at 550, down from last year’s high of nearly 850. Lower energy and food prices have been the significant drivers of the SPGSCI’s drop this year. Chair Powell is undoubtedly aware of the drop in raw material prices, though he rightfully expects it will take some time to impact retail prices.

Job growth remains uncomfortably strong as the Fed looks for slowing economic activity to justify an end to the current tightening cycle. Economists expect that continued expansion in hiring will keep rates higher for longer. For now, good news is bad news regarding employment growth.

The question for businesses, especially those that do business internationally, is this: how are you handling risk on your forex exposure? Between the volatile nature of FX markets and the impact that the strong dollar is having on transactions between international customers and clients, prudential businesses are looking for ways to hedge risk and avoid damage to their bottom lines. 

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