Deutsche Bank Research said softer US PCE inflation has led markets to scale back expectations for further Federal Reserve tightening, leaving the Dollar Index slightly weaker. December hike pricing fell by 7.3bps over the week to 32bps, and that repricing pushed the 2-year Treasury yield down 8.7bps over the week, including a 3.1bps drop on Friday. The 10-year yield also slid 8.4bps over the week and 2.3bps on Friday, ending at 4.37%, while European Central Bank December hike pricing declined by 12.8bps to 24bps.
Attention now turns to labour-market releases and upcoming central-bank commentary. US payroll growth is forecast to slow to 75k from 172k, with private payrolls seen rising about 90k, while the jobless rate is expected to hold at 4.3%. Average hourly earnings are projected unchanged at 0.3% month-on-month. Separately, Fed Chair Warsh is due to speak on Wednesday at the ECB’s Sintra forum, with Deutsche Bank’s economists still pencilling in two rate increases later this year and expecting limited near-term guidance as markets focus on incoming data.
Market Repricing and Strategy Opportunities
We see the market pulling back its bets on future Fed rate hikes, reacting to softer inflation numbers. The latest Core PCE reading for May came in at 2.6% year-over-year, just below expectations and continuing a cooling trend from earlier in the year. This has pushed down Treasury yields and put some pressure on the US Dollar.
With key labor data due this Thursday and the Fed Chair speaking on Wednesday, we anticipate a rise in short-term volatility. The market is waiting for a clear signal, creating an opportunity for strategies like options straddles on major index ETFs. These trades can profit from a large price move in either direction following the news.
We are closely watching the interest rate futures market, particularly Secured Overnight Financing Rate (SOFR) futures. While the market is pricing in only 32 basis points of hikes by December, we feel there is value in positioning for a more hawkish path. This sets up a trade that profits if upcoming data forces the market to price in the two full hikes some economists still expect.
Currency Positioning and Payroll Focus
On the currency side, the weaker dollar trend presents opportunities in FX options. We’re looking at call options on pairs like the EUR/USD, which has already climbed from 1.07 to around 1.09 this past month. This allows us to bet on further dollar weakness while clearly defining our maximum risk if the trend reverses.
The focus this week will be Thursday’s payroll report, with expectations for a significant slowdown to just +75k jobs. We are cautious, as initial non-farm payroll prints in the second quarter have historically seen downward revisions in three of the last five years. A number well above or below this forecast will likely cause a sharp repricing in rate expectations and move the market.
