Lofty expectations provide a high hurdle for further US dollar gains

The US dollar has continued to trade at modestly weaker levels following the release of the latest Nonfarm Payrolls report for June. After hitting an intra-day high of 92.741 on Friday, the US Dollar Index has since dropped back alongside US yields. According to economists at MUFG Bank, USD risks may become more balanced after the NFP report.

Strong NFP not sufficient to further bring forward expectations for the Fed rate hikes

“US dollar weakness following the latest report is most likely a reflection of positioning going into the report and lofty expectations for employment growth. Market participants had again been expecting a blowout NFP report potentially showing employment growth of greater than one million, and had already cut back short US dollar positions in the proceeding weeks. Those lofty expectations continue to provide a very high hurdle for positive US economic data surprises.”

“On balance we still believe the Fed is more likely to wait until early in 2023 before beginning to raise rates which are slower than current market pricing. As such we see scope for the US dollar to give back some of its recent sharp gains as fears over even earlier tightening ease for now.”

“The main risk in the week ahead is posed by the release on Wednesday of the latest FOMC minutes from the 16th June meeting at which the Fed delivered the hawkish policy surprise. In the accompanying press conference Fed Chair Powell acknowledged that the Fed started preliminary discussions on QE tapering plans. The minutes are expected to reveal further details of those plans. However, we are not expecting the minutes to reveal plans for an earlier than expected start date for QE tapering or faster than expected pace of tapering.”

“We expect QE tapering to begin later this year or early next year and to be a gradual process at least throughout the first half of 2022. After the hawkish market reaction to the last FOMC meeting, we would be surprised to see another hawkish surprise in the minutes especially as the Fed leadership has since attempted to dampen the initial market reaction.”

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