Debt Ceiling And Dovish Powell Drive Currency Market Sentiment

The stalemate over the U.S. debt ceiling, uncertainty over monetary policy in the U.S. amidst sticky inflation, and concerns about the slowing growth in China, formed the backdrop for currency markets in the week spanning May 15 to May 19. During the week, the U.S. Dollar strengthened against the Euro, the British Pound and the Japanese Yen while it marginally lost ground to the Australian Dollar. Also, the Chinese Yuan (USD/CNY) crossed the psychologically important level of 7 against the U.S. Dollar for the first time since December.

The Dollar Index (DXY) which measures the Dollar’s strength against a basket of 6 currencies gained more than half a percent during the week ended May 19, rising to 103.20, from 102.68 a week earlier. Though the DXY touched the week’s low of 102.20 after muted retail sales data, it rebounded and touched a two-month high of 103.62 by the end of the week. Hopes of a conclusive resolution of the U.S. debt ceiling deadlock and rate hike expectations supported the Dollar. However, DXY ended the week at 103.20 after the much-awaited comments by Jerome Powell.

Contrary to the tone of Fed speakers who spoke earlier, Chair Jerome Powell sounded less hawkish than feared. Powell’s comments included hints that the tightening liquidity conditions obviated the need for big rate hikes to achieve monetary policy goals.

The euro declined 0.42 percent to the Dollar in the week beginning May 15 amidst a resurgent Dollar. From the level of 1.0848 at the end of the previous week, the pair dropped to 1.0802 by end of the recent week despite hawkish comments from ECB officials and stronger-than-expected producer prices in Germany. The EUR/USD pair touched a high of 1.0905 on Wednesday and a low of 1.0760 on Friday.

The British pound’s losses to the U.S. Dollar were nominal at 0.10 percent, amidst Bank of England Governor Andrew Bailey, reiterating his commitment to the 2 percent inflation target. He also simultaneously expressed confidence that that inflation would fall sharply over the coming months, beginning with the April number.

The GBP/USD pair which was at 1.2457 on May 12 finished trading at 1.2444 on May 19. The week’s trading range was between 1.2548 touched on Tuesday and 1.2391 touched on Thursday. Data released on Tuesday had shown the unemployment rate in the U.K. edging up to 3.9 percent in March, versus 3.8 in the previous period.

The Australian Dollar edged higher against the U.S. Dollar, courtesy the hawkish stance by the Reserve Bank of Australia as revealed in the Minutes of its previous meeting released on Monday. The AUD/USD pair edged up to 0.6650 in the week ended May 19, from 0.6646 a week earlier amidst hints of further rate hikes by the RBA. The high point of 0.6711 was scaled on Tuesday whereas the lowest level of 0.6604 was touched on Thursday.

The Japanese yen lost around 1.65 percent to the Dollar during the week ended May 19 as safe haven demand subsided following a dissipation in the banking crisis and hopes deepened of a resolution of the debt ceiling crisis. The USD/JPY pair surged to 137.95, from 135.71 at the end of the previous week amidst dovish comments and warnings against premature policy change by the Bank of Japan officials. The pair ranged between the low point of 135.60 on Monday and the high point of 138.76 touched on Thursday.

Amidst economic data updates from China that questioned the strength and depth of the post-pandemic economic rebound, the USD/CNY pair crossed the psychological mark of 7 to the Dollar and finished trading on May 19 at 7.0060, versus 6.9575 at the end of the previous week. The week’s trading ranged between a low of 6.9475 and a high of 7.0602.

The Dollar has eased post the Fed Chair’s dovish commentary on Friday. The CME FedWatch tool currently shows a 17.5 percent probability for a 25-basis points rate hike in the next review versus 20.1 percent a week earlier.

The Dollar Index or DXY has since fallen 0.13 percent to 103.07. In tandem with the Dollar’s retreat, the EUR/USD pair has increased to 1.0821 and the GBP/USD pair has strengthened to 1.2461. The AUD/USD pair has however fallen to 0.6639 whilst the USD/ JPY pair has increased to 138.38.

With the June 1 deadline indicated by the U.S. Treasury department looming, market focus has converged on the debt ceiling crisis in the U.S. As U.S. government bonds underpin the global financial system, any default, resulting in downgrade or treasury market dysfunction could trigger massive volatility not just across currency markets but also potentially spill over to equity and debt markets as well as engulf the entire financial market landscape.

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