USD: Softer tone as Fed seen delaying cuts – MUFG

MUFG’s Lloyd Chan notes the US Dollar (USD) has softened as US Dollar Index (DXY) retests support and US yields fall, while equities hit new highs. Recent US data show stronger ADP employment but worrying ISM services inflation and weak employment. MUFG argues this creates a policy dilemma and sees the Federal Reserve (Fed) more likely to delay rate cuts than resume hikes over the next year.

Policy dilemma weighs on Dollar outlook

"On the data front, April ADP employment rose to +109k from +61k in March. But the latest ISM services survey is more concerning. Prices paid rose to a three year high, while services employment stayed in contraction."

"From a policy standpoint, this creates a dilemma for policymakers. We think the Fed is more likely to delay on rate cuts rather than to pivot back to rate hikes. And should there be meaningful deterioration in labour market conditions, monetary policy may err on the side of easing over the next 12 months – an outcome that remains underpriced by markets."

"The dollar softened, with DXY retesting support near 97.60, while US 10-year yields fell around 8bp to 4.35%. Brent prices have fallen back to around the $100/bbl level and is down nearly 20% from its 30 April intraday high of USD126.41/bbl. Meanwhile, the S&P 500 pushed to new highs, helping to contain the dollar decline."

"Signs continue to point to limited appetite for further escalation in the Middle East. The US has reportedly presented Iran with a memorandum of understanding aimed at de escalating tensions and gradually reopening the Strait of Hormuz. The proposed deal would involve Iran committing to a moratorium on nuclear enrichment in exchange for US sanctions relief."