Sovereign International Daily Market Report

Resilient US economic data triggers broad dollar rally

A strong set of macroeconomic data out of the US sent the dollar higher across the board on Thursday, as investors continued to raise their expectations for Federal Reserve interest rates.

According to revised data, the US economy expanded by a larger-than-expected 2% annualised in the first quarter of the year, after investors had braced for only a very modest upward revision to the 1.3% initial estimate. Fixed investment and government spending were revised downwards, although this was more than offset by an upgrade to consumer spending, the unequivocal heartbeat of the US economy. While this still marks the slowest pace of expansion since the second quarter of 2022, markets had been bracing for a more pronounced slowdown that, as of yet, has clearly not come to pass. Indeed, the data should allay fears that the US economy is heading for a recession this year, which we see as increasingly less likely by the week.

Labour market data out on Thursday was equally impressive. Initial jobless claims dropped sharply last week, falling back to 239k from 265k, the lowest level in a month and well below consensus (265k). US dollar bulls will be licking their lips at the strength of yesterday’s data, as this no doubt makes additional Federal Reserve interest rate hikes increasingly likely. Futures are now pricing in around an 85% implied probability of another 25bp hike at the July FOMC meeting (up from 75% on Wednesday), and a terminal rate just shy of 5.5%. This provided good support for the greenback yesterday, which ended higher against most currencies and looks set to end June on a solid footing, having sold-off against most of its peers since the beginning of the month.

Speaking during the Sintra conference in Portugal this week, chair of the FOMC Jerome Powell sounded a hawkish note, reiterating the bank’s view that at least two more US rate hikes could be on the way before the end of the tightening cycle. Indeed, there appears a general consensus among central bank chiefs that more work needs to be done to normalise price pressures, particularly amid tight labour markets that are characterised by steadily increasing wages. ECB president Lagarde explicitly noted that the bank would likely hike rates again in July, while BoE governor Bailey said that the MPC would do ‘what is necessary’ to get UK inflation to target, without either confirming or pushing back on the market’s expectations for rates.

Attention among market participants will quickly shift to this morning’s Euro Area inflation report at 10:00am BST (11:00am CET). Thursday’s HICP data out of Germany, which both bucked the recent downturn and surprised to the upside, was perhaps a sign of things to come. Economists’ are eyeing an easing in the headline inflation rate to 5.6% (from 6.1%), though the core number, the ECB’s preferred metric, is expected to increase to 5.5% (from 5.3%).

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