Dollar Stages Strong Comeback After Resilient US Economy Data

The dollar made significant gains on Thursday, climbing 0.3% against its global peers, as reports on consumer spending and labor market showed signs of a resilient US economy. This upswing marks the second week in a row that the greenback has strengthened, with some analysts attributing this resurgence to improved economic indicators.

A key factor contributing to the dollar's rise was the retail sales data for June, which surpassed expectations. The numbers demonstrated a robust consumer spending sector, underscoring the strength of the US economy despite concerns over tariffs imposed by President Donald Trump. Furthermore, weekly initial jobless claims were lower than anticipated, adding weight to the narrative that the economy is holding its ground.

Market participants now view the likelihood of an interest-rate cut at the September Federal Reserve meeting as a coin toss, down from being considered a certainty just days prior. This shift in market sentiment has led traders to reassess their expectations regarding monetary policy, with many now believing that the Fed may not be inclined to cut rates as aggressively as previously thought.

Aroop Chatterjee, a strategist at Wells Fargo, highlighted this change in perspective: "The market has refocused on the narrative of a resilient US economy with burgeoning inflation pressures. Market pricing for Fed cuts continues to decline."

Yields across most US Treasuries rose during Thursday's trading session, reflecting increased optimism about the economy's prospects. The two-year note yield, particularly sensitive to changes in monetary policy, climbed by three basis points to 3.92%. This upward trend suggests that investors are becoming more confident in the economic outlook.

Thursday's gains for the dollar represented a rebound from the previous day's decline, which was triggered by Trump's consideration of removing Fed Chair Jerome Powell. Although Trump later walked back this threat, the initial reaction had sent shockwaves through financial markets, sparking concerns about political interference at the central bank.

Kokou Agbo-Bloua, Societe Generale SA's global head of economics & cross-asset research, explained the implications: "Any central bank's biggest asset is its credibility. If that were to go, through a firing, the market will take it very badly." Furthermore, speculation about potential replacements for Powell would increase volatility in US asset prices and weaken the dollar.

Market participants are expected to remain vigilant regarding any developments related to Trump's stance on Powell, as well as ongoing trade tensions between the US and other countries. George Saravelos, global head of FX research at Deutsche Bank AG, noted: "This underlying story will act as a big headwind both to the dollar and to fixed income, until it gets resolved one way or another."

Despite concerns over these issues, better-than-expected US data has continued to support the greenback. Yusuke Miyairi, a foreign-exchange strategist at Nomura, observed: "The US data haven't shown any strong indication of growth weakness." While investors had anticipated tariffs to have an adverse impact on the economy, the actual performance has not borne out these expectations.

Market Expectations and Treasury Activity

Activity in options linked to the Secured Overnight Financing Rate (SOFR) revealed traders seeking to hedge against the possibility that the Fed will cut rates more aggressively than currently priced. SOFR futures volumes reached six million for the first time in about six weeks, indicating a heightened level of market activity as traders reassessed their positions.

Torsten Slok, chief economist at Apollo Management, emphasized: "The market is way, way too eager to price in cuts." He believes that the Fed will need to assess the inflationary impact of tariffs and deportations before making any decisions on interest rates. As a result, Slok foresees only one rate cut by the end of 2025, whereas market expectations lean towards two cuts.

The strong performance of the dollar this week underscores its resilience in the face of trade tensions and speculation about central bank policy. For now, investors appear to be prioritizing economic data over politics, with better-than-expected US indicators supporting the greenback's gains.