As U.S. debt ceiling worries appear to ease, traders are now shifting their focus back to the Federal Reserve to gauge the dollar’s next move.
Fueled by the Fed’s rapid interest rate hikes in 2022, the greenback’s value hit its highest level in more than two decades back in September, but retreated sharply afterward.
But the currency has bounced back. The ICE U.S. Dollar Index DXY, -0.74%, which measures the currency’s strength against a basket of six major rivals, rose 2.6% in May, after back-to-back losing months, according to FactSet data. The index stumbled to kick off June, falling 0.7% on Thursday.
Some investors are worried that a resurgent dollar would weigh on equities, undercutting a rally that on Thursday sent S&P 500 SPX, +0.99% above 4,200, a longtime resistance level, leaving the large-cap benchmark to post its highest close since Aug. 16.
President Joe Biden and House Speaker Kevin McCarthy reached a deal on a debt-ceiling package over the Memorial Day weekend and the House of Representatives passed the bill on Wednesday. It is now up to the Senate.
Read: Debt-ceiling deal: Here’s what’s next as Senate prepares to vote
As the market puts fears of a U.S. default behind it, it is “probably a benefit” for the dollar, said Ross Mayfield, investment strategy analyst at Baird.
But as the greenback’s May performance shows, debt-ceiling worries haven’t been a headwind.
Instead, the greenback has been primarily reacting to the expectations of interest rates for the past few days, Mayfield said.
Mike Reynolds, vice president of investment strategy at Glenmede, echoed the point. “Every step closer to expectations for higher rates should theoretically be a tailwind for the dollar. The opposite is also true,” Reynolds said.
More Fed speakers are now talking about the possibility of skipping a rate hike in June, but not calling for a lengthy pause.
“I think we’re close to where we need to be, [to] sit and hold for a while. I don’t know if we’re there yet, that’s why we skip this one and see how it goes,” Philadelphia Fed President Patrick Harker told MarketWatch this week. “And if we need to raise, we raise at the next meeting.”
MarketWatch Interview: Fed’s Harker says skipping June rate hike is returning to normalcy
Fed-funds rate traders are now pricing a 23% chance that the Fed will raise its interest rate in June. That’s down from 67% on Tuesday. Meanwhile, fed fund futures reflect a 46.7% chance that the Fed will keep the interest rate unchanged in both June and July.
“In this case, falling expectations for fed funds in the near-term could be bearish for the dollar,” Reynolds said. “With that said, the impact is likely marginal, since the debate seems to be centered around hiking in June or holding off until July. The difference of one month’s time is likely immaterial for this purpose.”
The dollar is likely to weaken in the intermediate term, according to Mayfield. The greenback is near the top end of its range for the past decade despite its pullback since last fall, Mayfield said.
In addition, “whenever the kind of global growth narrative flips back on and you have risk-on, particularly in emerging markets, that’s usually a headwind for the dollar,” Mayfield noted.
Edward Moya, market analyst at Oanda, said it’s likely that the dollar trade will stay choppy, until investors get a more clear idea of how severe of a slowdown may be in store for the U.S. economy.
“A lot of people are still unsure whether or not we’re going to see a hard recession in the U.S.,” Moya said. “If that’s the case, you’re probably going to see the dollar still be somewhat supported here.”
U.S. stocks ended Thursday with gains. The Dow Jones Industrial Average DJIA, +0.47% finished up 0.5%, and the S&P 50o rose 1%. The Nasdaq Composite COMP, +1.28% rallied 1.3%.