US dollar slides on profit taking, Mester’s comments

The Dollar Index temporarily dipped below 104.20 on Tuesday, one day after reaching its best level in nearly three months on good economic data and the Fed’s hawkish stance on interest rates, with the US service sector exhibiting resilience, prompting markets to disregard an interest rate cut in March.

Loretta Mester, president of the Federal Reserve Bank of Cleveland, has warned about the hazards of tight monetary policy and its influence on the labour market.

The Fed’s hawkish stance, supported by good employment data and Q1 growth, caused expectations for Fed rate cut to fade, favouring the dollar in recent sessions.

Several Fed officials will contribute additional comments this week, which might influence the pace of the USD as markets await new economic data. Mester emphasized the risk that the employment market could cool faster than expected as a result of tight monetary policy, while also anticipating that the Fed will gain confidence to cut this year.

US Treasury yields are falling, with the 2-year, 5-year, and 10-year notes trading at 4.40%, 4.04%, and 4.09%, respectively. CME’s FedWatch Tool estimates a 15% chance of a rate cut in March.

The DXY bulls give up the 20-day Simple Moving Averages (SMAs), suggesting a bullish bias in the longer-term market sentiment.

Robust US economic data, including a blowout unemployment report on Friday, and recent remarks from Fed Chair Jerome Powell have quashed speculation about early and steep rate cuts by the U.S. central bank that the market had widely anticipated.

Cleveland Fed President Loretta Mester said on Tuesday that if the U.S. economy performs as she expects, it could open the door to rate cuts. But Mester said she was not ready to provide timing for easier policy amid ongoing inflation uncertainty.

Other central bankers agreed. The European Central Bank doesn’t need to rush cutting rates, policymaker Boris Vujcic told Reuters, arguing it will be better for ECB credibility to be sure that inflation is decisively under control.

The dominant storyline for traders is a return to the US economic exceptionalism trade from the third quarter of 2023.

Now traders are wondering if instead of whether the US economy will get a soft landing or recession, whether investors could have no landing or re-acceleration this year.