Robust US Data and Hawkish Fed Underpin USD Strength, PCE Inflation Data (June 28th) in Focus
Monday, 24 June, Week 26: The US dollar has enjoyed a period of strength over the past five months, underpinned by robust economic data and a hawkish Federal Reserve. However, recent signs of slowing growth and a cooling labour market, coupled with persistent inflation, are creating uncertainty about the future path of monetary policy. This report delves into the fundamental factors influencing the USD, analysing key economic indicators, fiscal and monetary policy, and geopolitical developments to provide insights for Forex traders. The upcoming release of the Fed's preferred PCE inflation gauge on June 28th could be pivotal in shaping the USD's near-term outlook.
Currency
The US dollar has experienced upward support over the past five months, primarily driven by the Federal Reserve's aggressive monetary policy tightening to combat inflation. The Fed's rate hikes, which began in early 2023, have made the USD more attractive to yield-seeking investors, boosting its value against major currencies. This trend was further reinforced by the relative strength of the US economy compared to other developed nations.
However, recent data releases suggest that the US economy is slowing, with Q1 2024 GDP growth revised down to 1.3%. While the labour market remains resilient, with strong job gains in May, the unemployment rate has ticked up, and employment levels have declined, indicating some cooling. This mixed picture, coupled with persistent inflation, is creating uncertainty about the Fed's future policy path.
Looking ahead to the next five weeks, the USD's trajectory will likely hinge on the upcoming PCE inflation data release on June 28th. A hotter-than-expected reading could bolster the Fed's hawkish stance, potentially leading to further rate hikes and continued upward support for the USD. Conversely, a softer inflation print could fuel expectations for a sooner-than-anticipated rate cut, potentially putting downside pressure on the greenback.
Other key events to watch include the release of Q2 GDP data, the July FOMC meeting, and further commentary from Fed officials. These events will provide further clues on the Fed's policy intentions and the health of the US economy, influencing the USD's direction.
Fiscal Policy
The US fiscal policy stance has been relatively neutral in recent months, with the government focused on balancing spending priorities with deficit reduction. The Fiscal Responsibility Act of 2023, which temporarily suspended the debt limit, provided some certainty regarding government spending. However, the upcoming expiration of the debt limit suspension in January 2025 could create renewed uncertainty and volatility in financial markets.
The 2025 Budget, released in March, proposes significant investments in infrastructure, clean energy, and social programs, while also aiming for deficit reduction through tax reforms targeting wealthy individuals and corporations. However, the political feasibility of these proposals remains uncertain, and their impact on the economy and financial markets is yet to be fully assessed.
Over the next five weeks, fiscal policy is unlikely to be a major driver of USD movements. However, traders should monitor developments related to the debt ceiling and the implementation of the 2025 Budget for potential shifts in sentiment.
Economics
Economic Growth
The US economy has shown signs of slowing in recent months, with Q1 2024 GDP growth revised down to 1.3%. This moderation is attributed to weaker consumer spending, a larger drag from inventory reductions, and a downturn in federal government spending. However, non-residential investment was revised higher, and residential investment jumped more, suggesting some areas of resilience.
Trading Economics forecasts Q2 GDP growth at 1.5%, indicating continued moderation. The Atlanta Fed's GDPNow model, as of June 19th, estimates Q2 growth at 1.8%. These forecasts suggest that the US economy is likely to remain on a path of slowing growth in the near term.
Labour
The US labor market remains resilient, with non-farm payrolls surging by 272K in May, exceeding expectations. However, the unemployment rate ticked up to 4%, and employment levels declined, suggesting some cooling. Average hourly earnings rose 0.4% in May, indicating moderate wage pressure.
The upcoming release of the June employment report will be closely watched for further clues on the health of the labor market. A continued trend of strong job gains but rising unemployment could reinforce the narrative of a cooling labor market, potentially influencing the Fed's policy decisions.
Price Changes
Inflation in the US has shown signs of easing, with the annual inflation rate slowing to 3.3% in May, the lowest in three months. Core inflation also eased to 3.4%, the lowest since April 2021. However, both measures remain above the Fed's 2% target, and shelter costs continue to be a key driver of inflation, rising 0.4% in May for the fourth consecutive month.
The upcoming release of the PCE inflation index on June 28th will be crucial in shaping the Fed's policy outlook. A hotter-than-expected reading could reinforce the Fed's hawkish stance, potentially leading to further rate hikes. Conversely, a softer inflation print could fuel expectations for a sooner-than-anticipated rate cut.
Trade
The US trade deficit widened to $74.6 billion in April, the largest since October 2022, driven by a surge in imports and a meagre increase in exports. The largest trade gap was recorded with the European Union, while the deficit with China narrowed.
The trade balance is likely to remain a drag on US economic growth in the near term, as the stronger dollar and slowing global demand weigh on exports. However, the recent narrowing of the trade deficit with China could provide some support.
Monetary Policy
The Federal Reserve left the fed funds target range steady at 5.25%-5.50% for a seventh consecutive meeting in June, in line with forecasts. However, the dot plot showed policymakers now see only one rate cut this year and four reductions in 2025, compared to three cuts projected for each year in March. This shift signals a more hawkish stance, reflecting the Fed's concerns about persistent inflation.
Fed Chair Powell emphasized the need for "greater confidence" that inflation is moving sustainably towards 2% before easing policy. He stated, "We will need to see more good data to bolster our confidence that inflation is moving sustainably toward 2 percent."
Over the next five weeks, the Fed's policy stance will likely remain data-dependent, with the PCE inflation data on June 28th being a key focal point. A hotter-than-expected reading could reinforce the Fed's hawkish stance and potentially lead to further rate hikes. Conversely, a softer inflation print could fuel expectations for a sooner-than-anticipated rate cut.
Geopolitics and Market Themes
Russia-Ukraine War
The ongoing war in Ukraine continues to create geopolitical uncertainty and volatility in financial markets. The conflict has disrupted global supply chains, contributed to higher energy prices, and fueled inflationary pressures.
Key Developments:
Russia's offensive in eastern Ukraine continues, with both sides suffering heavy casualties.
Western countries are providing ongoing military and financial support to Ukraine.
The conflict has strained relations between Russia and the West, leading to increased sanctions and geopolitical tensions.
Market Impact:
The war has contributed to risk aversion in financial markets, boosting safe-haven assets like the USD.
Higher energy prices have fueled inflationary pressures, supporting the Fed's hawkish stance.
The conflict's impact on global supply chains has contributed to supply-side inflation.
US-China Tensions
Tensions between the US and China remain elevated, with ongoing disputes over trade, technology, and security. The two countries are engaged in a strategic competition for global influence, creating uncertainty and potential for market volatility.
Key Developments:
The US has imposed tariffs on Chinese goods, and China has retaliated with tariffs of its own.
The US is restricting Chinese access to advanced technologies, citing national security concerns.
The US is strengthening alliances in the Indo-Pacific region to counter China's growing influence.
Market Impact:
Trade tensions have disrupted global supply chains and contributed to uncertainty in financial markets.
The technology rivalry is impacting investment decisions and innovation in both countries.
The geopolitical competition is creating a risk premium in financial markets, supporting safe-haven assets like the USD.
Global Economic Slowdown
The global economy is facing a slowdown, with growth projections being revised downwards due to factors such as high inflation, rising interest rates, and geopolitical uncertainty. This slowdown is creating headwinds for the US economy, potentially impacting the Fed's policy decisions.
Key Developments:
The IMF has downgraded its global growth forecast for 2024, citing persistent inflation and tighter monetary policy.
Europe is facing an energy crisis due to the war in Ukraine, impacting economic activity.
China's economy is slowing due to COVID-19 lockdowns and a property market downturn.
Market Impact:
The global slowdown is weighing on demand for US exports, potentially widening the trade deficit.
The weaker global growth outlook is contributing to risk aversion in financial markets, supporting safe-haven assets like the USD.
The slowdown is creating uncertainty about the Fed's ability to achieve a soft landing for the US economy.
Conclusion
Upward Support Scenario
The USD could come under upward support in the next five weeks if the PCE inflation data on June 28th comes in hotter than expected, reinforcing the Fed's hawkish stance and potentially leading to further rate hikes. This scenario would be further supported by continued robust economic data, such as strong job gains and solid GDP growth, indicating that the US economy is weathering the global slowdown better than other developed nations.
Indifference Scenario
The USD could experience indifference in the next five weeks if the PCE inflation data comes in line with expectations, suggesting that inflation is easing but remains elevated. This scenario would likely keep the Fed on hold, maintaining its current restrictive stance while awaiting further data before making any policy adjustments. The USD's direction would then be driven by other factors, such as global risk sentiment and developments in other major economies.
Downside Pressure Scenario
The USD could come under downside pressure in the next five weeks if the PCE inflation data comes in softer than expected, fueling expectations for a sooner-than-anticipated rate cut. This scenario would be further supported by signs of a weakening US economy, such as slowing job growth or a decline in GDP, indicating that the Fed's rate hikes are having a more significant impact on economic activity.
References
Federal Reserve: https://www.federalreserve.gov/
FOMC Press Conference Transcript (June 12, 2024): https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20240612.pdf
Summary of Economic Projections (June 12, 2024): https://www.federalreserve.gov/mediacenter/files/FOMCprojtabl20240612.pdf
U.S. Bureau of Economic Analysis: https://www.bea.gov/
Gross Domestic Product (Second Estimate), Corporate Profits (Preliminary Estimate), First Quarter 2024: https://www.bea.gov/data/gdp/gross-domestic-product
U.S. International Transactions, 1st Quarter 2024 and Annual Update: https://www.bea.gov/data/intl-trade-investment/international-trade-goods-and-services
U.S. Census Bureau: https://www.census.gov/
Advance Monthly Sales for Retail and Food Services, May 2024: https://www.census.gov/retail/
Monthly New Residential Construction, May 2024: https://www.census.gov/construction/nrc/
U.S. International Trade in Goods and Services, April 2024: https://www.census.gov/foreign-trade/Press-Release/current_press_release/index.html
U.S. Bureau of Labor Statistics: https://www.bls.gov/
Consumer Price Index - May 2024: https://www.bls.gov/news.release/cpi.nr0.htm
The Employment Situation - May 2024: https://www.bls.gov/news.release/empsit.nr0.htm
Trading Economics: https://tradingeconomics.com/
University of Michigan: https://data.sca.isr.umich.edu/
S&P Global: https://www.spglobal.com/
Institute for Supply Management: https://www.ismworld.org/