The US Dollar Index (DXY) recorded its first pullback since the June 17 FOMC meeting, slipping 0.2% to 101.43 as PCE figures fuelled talk that US inflation peaked in May. Headline and core PCE inflation came in at 4.1% year on year and 3.4%, respectively, in line with expectations but still above the Fed’s 2% target. In derivatives markets, futures pricing puts the probability of a September Fed hike at 47.5%, the first move below 50% since the hawkish meeting.
Attention now turns to a crowded calendar, with June’s ISM manufacturing prices paid index expected on July 1 to fall to 79 from 82.1 in May, while nonfarm payrolls on July 2 are seen easing to 115k after 175k in May. CPI data due on July 14 will be watched for how far lower oil prices feed into inflation dynamics, while the ECB’s Sintra forum may shape expectations for policy convergence. The central case implied by pricing is that rates stay restrictive for longer, potentially encouraging major currencies to consolidate after the post-FOMC USD surge.
Dollar Eases as Inflation Shows Signs of Peaking
We are seeing the US Dollar Index (DXY) ease from its recent highs, now trading around 105.8. This follows the latest Personal Consumption Expenditures (PCE) data showing core inflation at 2.8%, a sign that price pressures might be peaking. While this is still above the Fed’s 2% goal, it is a clear move in the right direction.
The futures market is now pricing in only a 40% chance of a rate hike at the Fed’s September meeting, which is the first time it has dropped below even odds in over a month. We will be watching for the June ISM manufacturing report next week, which is expected to show continued softness in the factory sector. Minneapolis Fed President Neel Kashkari has recently stated that the job is not yet done on inflation, which keeps some uncertainty in the market.
Traders should be cautious ahead of the non-farm payrolls report due out on July 10th. Current expectations are for a slowdown to 160,000 jobs, a noticeable drop from May’s surprisingly strong 210,000 print. The Fed has been intentionally vague on its future plans, emphasizing that its decisions will depend entirely on incoming data.
Volatility and Policy Outlook Point To Range-Bound Trading
This setup suggests that implied volatility in currency options, particularly for the EUR/USD pair, could be too high. Selling volatility through strategies like short strangles could be an effective way to position for a period of range-bound trading. Historically, after a strong directional move like the dollar has had, a period of consolidation often follows as the market digests the new economic landscape.
The recent decline in WTI crude oil prices to below $75 a barrel is providing some relief to the economy. We do not believe central banks will see this as a green light to cut rates. Instead, they will likely use lower energy costs as a buffer that allows them to keep policy restrictive for longer without breaking the economy.
If the European Central Bank also holds rates steady while dealing with its own slowing growth, we will see more convergent monetary policy stances between the major central banks. This would reduce the reasons for continued, aggressive US dollar strength. A period of consolidation in major currency pairs now seems more likely than a continuation of the dollar’s surge.
