Dollar Extends Gains Amidst Debt Drama

(RTTNews) - Despite all the noise surrounding the U.S. debt limit and the negotiations to avert a default, the Dollar extended gains during the week ended May 26. The Dollar's surge drove the euro, the British pound, the Australian Dollar and the Japanese yen lower.

Renewed rate hike fears turned out to be the prime currency market catalyst, driving the Dollar higher by almost a percent over the course of the week ended May 26. From a dovish narrative that spilled over from the week ended May 19 triggered by Federal Reserve Chair Jerome Powell's hints of a pause, markets transitioned swiftly to a possible rate hike in the next review due on June 14.

While the Fed Minutes released on Wednesday added to uncertainty regarding monetary policy, hawkish commentaries from Fed officials over the course of the week suggested the interest rates in the U.S. would need to remain higher for a prolonged period. Data released on Friday showed core PCE inflation, which excludes food and energy prices increase 0.4 percent month-on-month in April versus expectations for it to be steady at 0.3 percent.

In this backdrop, the CME Fed Watch tool showed the probability for a 25-basis points rate hike rising to 64.2 percent on Friday, from 36.8 percent a week earlier.

Markets seeking a safe haven in the dollar amidst the threats of a potentially catastrophic debt default supported the Dollar's surge. Rating agency Fitch flagging a potential downgrade in the event of a default also added to the safe haven demand for the greenback. Worsening political ties between the U.S. and China and traders dumping treasuries in favor of the greenback, all contributed to the Dollar's rally.

The Dollar Index, a measure of the Dollar's strength against a basket of 6 currencies surged 0.98 percent during the week, rising to 104.21, from 103.20 a week earlier. From the low point of 102.96 touched at the beginning of the week, the DXY surged steadily, touching a high of 104.42 on Friday.

The Dollar's strength caused the EUR/USD pair to fall 0.72 percent during the week, to 1.0724, from 1.0802 a week earlier. The pair dropped from the week's peak of 1.0832 touched on Monday to the week's lowest point of 1.0701 by Friday despite ECB President Christine Lagarde reiterating that the central bank needed to keep interest rates high to curb inflation in the medium term. Data released during the week showed that Germany's economy contracted slightly in the first quarter of 2023, and the prospect of a full-blown recession weakened sentiment for the euro.

The British pound too lost 0.81 percent against the Dollar over the course of the week. The GBP/USD pair closed the week ended May 26 at 1.2343, versus 1.2444 a week earlier. The pair ranged between the high of 1.2473 touched on Monday to the low of 1.2307 touched on Thursday.

Sentiment for the sterling remained mixed as inflation data released on Wednesday showed inflation dropping to 8.7 percent, from 10.1 percent earlier but not as low as 8.1 percent which the markets had expected. On the contrary, data released on Friday showed retail sales volumes in the U.K. rise by 0.5 percent in April, versus a 1.2 percent decline in March and exceeding market expectations of a 0.3 percent growth.

Despite positive PMI data revealing resilience in the economy, the Australian dollar remained pressured by its high exposure to China, where data revealed questions about the strength of the post pandemic economic rebound. The week ended May 26 witnessed the Australian Dollar plunge around 2 percent to the U.S. Dollar. The pair dropped to 0.6517, from 0.6650 a week earlier. The pair declined steadily over the course of the week plunging from Monday's weekly high of 0.6669 to Friday's weekly low of 0.6490.

The yen too suffered a massive decline against the U.S. Dollar over the course of the past week amidst an increasing monetary policy divergence. The USD/JPY pair surged to a high of 140.74 on Friday, before closing the week at 140.62. From the previous week's level of 137.95, the week ended May 26 recorded a rally of 1.94 percent for the pair reflecting the stark contrast between a still-hawkish Fed and a still-dovish Bank of Japan. The pair's low point was 137.49 touched in the beginning of the week.

With a deal to lift the debt ceiling apparently close to fruition, the currency markets are refocusing on the Fed as well as the liquidity drain that the debt limit hike could trigger. On the horizon are JOLTS job openings data for April, as well as PMI and jobs data for the month of May. Updates on inflation from Germany, France and Euro Area for the month of May, due in the current week could also sway currency market sentiment.

Amidst these developments and expectations, the Dollar Index is currently at 103.99. The EUR/USD pair has increased to 1.0728 whereas the GBP/USD pair is now at 1.2403. The AUD/USD pair has edged up to 0.6518. The USD/JPY pair has fallen to 139.73.