Assessing the 50-50 Risk: USD's Outlook and Market Expectations for a June Fed Hike

FX Daily: Trading the 50-50 risk

Despite the very strong headline US May payroll figure, rising unemployment and declining wage inflation are keeping markets from fully pricing in a June Fed hike (we expect a hold). Barring a big ISM services surprise today, the lack of other key inputs before next week’s CPI could keep the dollar capped. The RBA decision tomorrow is also a 50-50 decision

 

 

USD: Not enough to price in a June hike

The blowout May headline payroll number added fuel to the narrative of an extra tight US labour market, but the coincidental rebound in unemployment to 3.7% and slowdown in wage growth kept markets from going all-in on a June rate hike by the Federal Reserve. As discussed in this note by our US economist, payrolls and the unemployment rate are calculated through different surveys: the former by employers, and the latter by households. In practice, firms and households conveyed very different messages about the direction of the US labour market in May.

 

We think that, when adding the cooling off in wage inflation, and considering the diverging views within the FOMC, the case for a pause at the 14 June meeting should prevail. The last big risk event before the rate announcement is the 13 June CPI reading, while today’s ISM services figures (the consensus expects a mild improvement) might have a somewhat contained impact on rate expectations, barring major diversions from expectations. The FOMC has already entered the black-out period.

 

Markets are currently pricing in a 25-30% implied probability of a hike in June, while 21bp are factored in by the end-July meeting. We suspect that the pricing may not vary considerably, or that the narrative of a “50-50” chance of a hike in June may prevail until the CPI numbers next Tuesday – and barring a surprise there – into the FOMC announcement itself.

 

With markets not having received enough compelling evidence from the May jobs report to price in more than a 50% probability of a June hike, we feel that two-year USD swap rates, which rebounded to 4.73% after having declined to 4.51% on Friday, may struggle to find much more support this week.

 

Add in a period of potential market sentiment stabilisation now that the debt-ceiling saga has ended and we think the dollar's bullish momentum may dwindle into the FOMC meeting.

 

We see a higher chance of DXY stabilising around 104.00 or pulling back to 103.00. Some pro-cyclical currencies could emerge as outperformers in this period: the Canadian dollar, for example, may stay supported now that Saudi Arabia announced another one million barrels a day of oil production cuts and even if the Bank of Canada stays on hold on Wednesday, as long as it keeps the door open for a potential hike down the road.