LONDON—The dollar hovered close to its highest since March on Friday, as optimism over a breakthrough in U.S. debt ceiling talks and robust economic data reduced the chances of a series of U.S. rate cuts this year.
Negotiators for Joe Biden’s Democrats told the president on Friday that they are making “steady progress” in talks with Republicans aimed at avoiding a U.S. default, just days after Biden and top U.S. congressional Republican Kevin McCarthy underscored their determination to strike a deal to raise the government’s $31.4 trillion debt ceiling.
That eased fears of an unprecedented and economically catastrophic default, leading markets to revise their expectations of where U.S. interest rates could go.
At the same time, data pointing to a still-tight labor market, with the number of Americans filing new claims for unemployment benefits falling more than expected last week, also raised expectations that the Federal Reserve could raise rates again next month to tame inflation.
The dollar index eased 0.2 percent on the day, but held near two-month highs, having risen by nearly 2.5 percent in the last two weeks alone, as investors rushed to reassess their expectations for what the central bank might do next.
“The message from the Fed has been really hawkish. We know there has been this divergence between what the market’s expecting and what the Fed has actually been saying and that was always going to need to be reconciled at some point. We’re starting to see this play out in the FX market now,” City Index strategist Fiona Cincotta said.
“As far as expectations for a June rate hike are concerned, those have risen significantly in the last week. The market is pricing in a 40 percent chance and that is up from 15 percent a week ago,” she said.
Two Fed policymakers said on Thursday U.S. inflation does not look like it is cooling fast enough to allow the Fed to pause its tightening campaign.
Money markets show traders now believe U.S. rates will fall to around 4.86 percent by year-end, compared with an expectation for a drop to 4.25 percent just two weeks ago—reflecting how the chances of a flurry of rate cuts have dropped.
Investors currently hold bearish bets, or short positions, against the dollar versus other G10 currencies worth nearly $12 billion—the largest in almost two years. This would suggest there could be some incentive to unwind some of those bets, meaning the dollar has room to rally.
“It’s hard to buck the dollar’s bullish momentum now, as we also think some substantial squeezing of short dollar positions can be behind the move,” ING strategists said.
The dollar ceded some ground on Friday, but still held firm. It was down 0.3 percent at 138.25 yen, having risen to a six-month peak of 138.745 earlier on.
The euro rose 0.2 percent to $1.0793, just above its lowest for seven weeks, while sterling inched up 0.1 percent to $1.243, not far off its lowest in a month.
Among other major currencies, the Australian dollar took some heart from a pickup in commodity prices like copper and iron ore, rising 0.4 percent to $0.665.
In China, the yuan slid to its lowest since December, at 7.0237 per dollar, as data offered evidence of a sputtering recovery in the world’s second-largest economy.
