Dollar pulls back, but yen hits new 34-year low

Key US data could further weigh on Fed rate cut bets

The US dollar retreated somewhat against most of its major peers on Monday, losing the most ground against the risk-linked currencies kiwi, aussie and loonie, perhaps as the cooling Middle East tensions allowed investors to increase their risk exposures.

Having said that though, the fundamental drivers behind the dollar’s latest advance have not changed, which means that its latest pullback may be the result of some profit taking before the next leg north.

Following the reacceleration in US consumer prices for March and comments by several Fed officials that there is no urgency to ease monetary policy soon, investors are currently pricing in only 40 basis points worth of cuts for this year, far fewer than the Fed’s own projection of 75.

This week, dollar traders will have to evaluate the first estimate of GDP for Q1 and the core PCE index for March, on Thursday and Friday respectively, but they may start adjusting their positions as early as today when the preliminary S&P Global PMIs are released.

Another round of strong economic data could further weigh on Fed rate cut expectations, and perhaps make investors question whether any reductions will be needed at all this year. This could drive Treasury yields higher and thereby add more fuel to the dollar’s engines.

Yen extends slide, BoJ decision awaited

Even with the dollar pausing its latest rally, dollar/yen hit a fresh 34-year high at around 154.85. Traders may have become less concerned about intervention by Japanese authorities as the main driver behind the rally in dollar/yen has been the Fed’s ‘higher for longer’ stance.

Japanese officials have repeatedly highlighted that they will not hesitate to act if the moves are speculative and do not reflect fundamentals, and that they do not target a specific level, rather they are monitoring the pace of the yen’s decline.

Lately, they have been quiet, which means that they may have acknowledged that the latest rally in dollar/yen is driven by fundamentals, and this is evident by the latest rally in Treasury yields. Perhaps they will start ringing the alarm bells again if US yields correct notably lower and dollar/yen does not pull back.

For now, yen traders will shift their attention to Friday’s BoJ decision for clues and hints as to whether the yen’s slide constitutes a risk to inflation and whether officials are thinking of delivering their next rate hike earlier than previously thought. Currently, the market is expecting the next 10bps increase in July.

The euro gained today after Germany’s Composite PMI returned above 50 for the first time since June 2023. Although the manufacturing index remained well below that boom-or-bust zone, the notable increase in the services print was enough to spark some optimism. A similar picture was painted by the Eurozone prints a bit later, but according to money markets, investors remained convinced that the ECB will most likely begin cutting interest rates in June.

Wall Street gains, gold tumbles on risk appetite

On Wall Street, all three of its main indices rebounded, with the tech-heavy Nasdaq gaining more than 1% due to easing geopolitical concerns after Iran’s foreign minister downplayed Israel’s retaliatory drone strike, a move suggesting that they want to avoid further escalation.

In the absence of new attacks this week, equity investors will stay busy adjusting their portfolios based on the earnings results by key tech giants. The ball gets rolling today with Tesla reporting after the closing bell.

The risk-on trading environment weighed on gold, confirming that, despite the rally in the US dollar and Treasury yields, one of the forces pushing it north may have been safe-haven flows due to the Middle East tensions.

That said, calling for a trend reversal appears to be premature as there is no endgame to the Middle East conflict yet, while China’s demand remains unstoppable as the central bank, consumers and investors continue adding to their holdings.