Currency strategists believe the dollar's first weekly drop in more than a month is likely to be just a temporary setback as political and inflation risks return to focus.

The Bloomberg Dollar Spot Index extended its decline on Friday, moving further away from its year-to-date high set the previous week, as disappointing U.S. economic data weighed on the index. The decline came as election developments in Britain and France supported gains in sterling and the euro against the dollar.

Even the yen strengthened slightly against the dollar on Friday. The pair remains at depressed levels, and market participants are closely watching for the possibility of intervention by the authorities to support the yen.

The Bloomberg Dollar Spot Index fell 0.3% on Friday, then pared losses to end the week down 0.7%. The June nonfarm payrolls report showed slower hiring and wage growth, which reinforced expectations that the Federal Reserve will start cutting interest rates this year, sending the dollar index to a new intraday low.

Bloomberg Dollar Spot Index posts first weekly drop in seven weeks

Daniel Tobon, a foreign exchange strategist at Citigroup in New York, said the data "creates dovish risks for Powell's congressional testimony on Tuesday and Wednesday." Powell will appear before the U.S. Senate and House of Representatives this week to discuss the economy and monetary policy.

With the latest data showing the highest unemployment rate since late 2021 and other data pointing to weak economic growth, Powell is likely to be pressed by some lawmakers on why the Fed has been reluctant to lower borrowing costs. Last Tuesday, Powell said recent data suggested inflation was returning to a downward path, but he and his colleagues wanted to see that progress continue.

The June CPI report will be released after two days of testimony from the Fed chairman before Congress. Economists expect the core CPI, which excludes food and energy costs, to rise 0.2% for the second consecutive month in June. That would be the smallest consecutive increase since August last year, which may be comforting to Fed officials.

“We expect that soft inflation data in June, July and August will give the Fed enough confidence to start cutting rates before the September FOMC meeting,” said economists Anna Wong, Stuart Paul, Eliza Winger and Estelle Ou.

Still, it will take more for Topan and others to derail expectations of a stronger dollar in the second half of the year.

While the dollar still has room to fall this week, U.S. political risks and inflation trends should restore support for the greenback, according to strategists at Citigroup, Credit Agricole and Brown Brothers Harriman.

Toban expects "further tactical dollar weakness this week," but believes that risks from the U.S. election are ultimately positive for the dollar, "which may be further highlighted in the coming weeks," he said.

The U.S. presidential election in November, after debates that put Biden under pressure to drop out of the race and boosted former President Donald Trump’s chances of reelection, has fueled interest in inflation trades that benefit from loose fiscal policy and greater protectionism, including bets on a higher dollar and U.S. bond yields.

“Further underperformance of the dollar will only come if the inflation outlook becomes more benign,” said Valentin Marinov, head of G-20 FX research and strategy at Credit Agricole.

The situation in Europe

Sterling posted the biggest gain against the dollar last week as traders rushed to British assets following the Labour Party's resounding victory, anticipating a period of political stability and fiscal discipline in the UK.

The euro also rose more than 1% as French polls showed Marine Le Pen's National Rally would fall far short of an outright majority in Sunday's legislative election.

The euro has weakened against the dollar this year as the European Central Bank cut interest rates for the first time in years last month, while the Federal Reserve has taken an increasingly cautious stance as its fight against inflation has stalled.

“The U.S. economy is slowing but it’s still doing pretty well, so the Fed will remain cautious,” said Win Thin, head of global market strategy at Brown Brothers Harriman in New York.

The article is forwarded from: Jinshi Data