US Dollar Falls as Economic Data Reinforce Fed Pause Case

As investors are trying to figure out how the Fed’s plans may evolve in the coming months, they may pay extra attention to today’s ADP employment report for August and the second estimate of the US GDP for Q2, ahead of tomorrow’s core PCE index for July and the official employment report for August on Friday.

Although the GDP data is forecast to confirm that the economy grew 2.4% qoq SAAR in Q2, the ADP report is expected to reveal that the private sector gained significantly less jobs than in July, adding to the latest evidence of a weakening labor market. That said, despite the softening, yesterday’s job openings report pointed to still tight labor market conditions, with 1.51 vacancies for every unemployed person, slightly below June’s 1.54, but well above the 1.0-1.2 range that is considered consistent with a labor market that is not generating too much inflation.

On top of that, tomorrow, the core PCE index is forecast to have ticked up, and on Friday, even though nonfarm payrolls are forecast to have further slowed, wage growth is estimated to have remained elevated. Therefore, anything adding to the risk of stickier price pressures in the months to come may prompt market participants to consider again the likelihood of another hike by the Fed, which could allow US Treasury yields and the dollar to rebound.

Euro awaits key inflation test
Euro/dollar is likely to come under selling interest if US data revive Fed hike expectations, but the pair’s fate will not only depend on the US data. With investors split on whether the ECB should hike again in September, Eurozone’s preliminary inflation numbers for August, due out on Thursday, may attract special attention.

Combined with a set of PMIs that rang the recession alarm bells, a slowdown in inflation could tilt the scale towards a September pause. The opposite may be true in case the data points to a small rebound. Today, traders will have the opportunity to get a first taste of where inflation in the Euro area may be headed as the German CPI numbers are on the schedule. Therefore, euro traders may start adjusting their bets and positions as soon as today.

Stocks rally on the back of increasing Fed pause bets
With investors scaling back their Fed hike expectations and adding to their cut bets, Wall Street enjoyed another day of gains, with the tech-heavy Nasdaq adding 1.74%. High growth tech firms are more sensitive to changes in interest-rate expectations as they are mainly valued by discounting expected free cash flows for the quarters and years ahead.

Given that tech-giants have been the main drivers behind the latest rally on Wall Street, further changes in Fed pricing could continue leaving their mark on Wall Street. Therefore, anything amplifying the case of another hike could trigger a setback, while anything corroborating a pause may add further fuel to this week’s recovery. Overall, though, as long as the implied path points to a decent amount of rate reductions in 2024, it may be too early to start examining the case of a bearish trend reversal, even if this week’s data result in a new setback.