- The dollar closed last week with significant gains as investors slashed expectations for Fed rate cuts.
- The likelihood of a Fed cut in September has risen to 77%.
- The Canadian dollar fell to a 5-month low on Friday.
Currency futures fell on Friday as the dollar soared due to divergence in monetary policies between the Fed and other major central banks. At the same time, geopolitical tensions led to an increase in safe-haven demand for the dollar.
Bloomberg dollar gauge (Source: Bloomberg)
The dollar closed last week with significant gains as investors slashed expectations for Fed rate cuts. The shift in expectations came after the US jobs and CPI reports beat forecasts despite higher interest rates. As a result, markets have sharply lowered the likelihood of a rate cut in June to 26%. Meanwhile, the likelihood of a cut in September has risen to 77%. Furthermore, markets now expect only 46bps in Fed rate cuts this year.
The new and ever-changing outlook for Fed rate cuts puts the US well behind other countries in reducing interest rates. Most major central banks are considering cutting in June. This policy divergence gives the dollar an upper hand, leading to a decline in currency futures.
Meanwhile, Middle East tensions escalated when Israel killed a senior Iranian officer. As a result, there were fears in the market on Friday that Iran would retaliate. Historically, geopolitical tensions have forced investors to seek shelter in safe-haven assets like the dollar.
Due to dollar strength, the Canadian dollar fell to a 5-month low on Friday. At the same time, the policy divergence between the Fed and the Bank of Canada weighed on the loonie. The BoC is ready to lower interest rates, and markets expect the first cut in June. Canada’s economy has slowed, and inflation is on a clear downtrend. On the other hand, the US economy is resilient, and inflation has stalled. Investors now believe the Bank of Canada might cut interest rates before the Fed.
The same situation is in the Eurozone, where the economy has weakened and inflation is 2.4%. The European Central Bank has grown confident that inflation will reach the 2% target this year. Consequently, they have signalled the first cut in June. The divergence with the Fed has made US yields more attractive than German yields. The euro also hit a 5-month low on Friday.
Meanwhile, the yen fell to a new 34-year low amid dollar strength, leading to fears that Japanese authorities will intervene.
