Fed Chair Powell’s Testimony Triggers Sell-off

USD: Fed Chair Powell’s testimony triggers sell-off.

During the Asian trading session yesterday, the US dollar continued to trade at weaker levels, extending the decline from yesterday. This weakness in the US dollar has resulted in a rise in the EUR/USD pair, bringing it close to the 1.1000-level and approaching its highest point of the year in April at 1.1095.

The primary reason behind the sell-off of the US dollar yesterday was the semi-annual testimony on monetary policy delivered by Fed Chair Powell to Congress. The content and tone of Powell's comments were like those following last week's FOMC meeting. This provided some relief to market participants who had been concerned that a more hawkish message would be conveyed, potentially leading to an increased likelihood of two more rate hikes this year.

The absence of a more hawkish message has allowed the US rate market to anticipate only one additional hike at this stage. Currently, there are expectations of a 17 basis points increase by the next policy meeting on July 26th and 21 basis points by the subsequent meeting on September 20th. These developments align with my view that the US rate market will not fully price in a second hike unless there is stronger-than-expected US activity and inflation data in the coming months.

I maintain my belief that mounting evidence of disinflationary pressures soon will prompt the Fed to pause their rate hike cycle at the September FOMC meeting. Market participants will also closely monitor any indications that the US labour market is weakening further in response to higher rates. The recent increase in initial claims and today's upcoming release of data will attract more attention than usual, supporting my expectation of continued weakness in the US dollar this year.

In my FX Weekly report last week, I recommended a new long EUR/USD trade idea based on the anticipation of the US dollar's ongoing correction and reversal of last month's gains.

Taking a closer look at the comments from the semi-annual testimony, Fed Chair Powell mentioned that it may be reasonable to raise rates, but at a more moderate pace. This explains why the Fed decided not to increase rates this month, marking the first time during the current tightening cycle that they have abstained from doing so. However, they signalled their intention to raise rates twice more this year. By deferring the rate hike this month, the Fed now has additional time to evaluate incoming economic data before determining whether further policy tightening is necessary, although they have made it clear that the tightening cycle is not yet over.

I believe there is a higher possibility of another hike in July unless there is a series of significant negative surprises in the US economic data over the next month. In relation to the tight labour market conditions, Fed Chair Powell expressed some optimism regarding the decline in the number of voluntary quits, referring to it as a positive development. Powell is scheduled to speak before the Senate later today, but it is unlikely that his comments will have as much impact on the market as they did yesterday.

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