Dollar Index Strengthened by Fed Doubts and Geopolitical Tensions

The dollar index rose 0.4% on Wednesday, bolstered by doubts over the extent of Fed easing, upward pressure on global borrowing costs, and geopolitical tensions that favored the safe-haven U.S. currency. The Fed's beige book report highlighted a mix of lingering inflation and uneven economic expansion, aligning with recent survey results but slightly more pessimistic in outlook. This somewhat subdued report tempered Treasury yields and the dollar's earlier gains.

Euro Under Pressure Amid ECB Rate Cut Expectations

EUR/USD fell 0.40%, retreating further from Tuesday's failed attempt to clear May’s highs, which were near April's peak. German inflation exceeded forecasts, while core inflation held steady at 3.0%. Despite this, the ECB is still expected to cut rates at next week's meeting, although robust German economic indicators like real wages and consumer sentiment suggest the region's largest economy may not need additional monetary stimulus. Bund and Treasury yields rose, reflecting the broader trend of rising borrowing costs, but the EUR/USD decline was more tied to risk-aversion than yield spreads.

Upcoming U.S. Economic Data to Influence Fed Expectations

Looking ahead, market participants will closely watch key U.S. economic data, including Friday's core and overall PCE reports, and next week's ISMs, JOLTS, and May employment data. These releases will be critical in shaping Fed rate cut expectations, which have significantly decreased to 31 basis points for 2024 from 160 basis points earlier this year.

Yen Under Pressure Amid USD/JPY Gains

The yen remains under pressure as USD/JPY rose 0.3%, approaching the significant 157.99 level, which is the May 1 high before the suspected intervention-driven plunge to 153. The pair received fresh buy signals, with the 76.4% Fibonacci retracement of the April-May decline likely coming into play at 158.26. Despite intervention risks, dwindling Fed rate cut pricing and the modest expectations for BoJ hikes keep carry trade demand robust.

Complex Interplay Between Economic Data and Central Bank Expectations

EUR/USD's decline highlights the complex interplay between economic data and central bank expectations. The euro faced pressure despite stronger German inflation data, reflecting concerns over ECB rate cuts and broader risk-aversion. The pair’s movement will remain sensitive to upcoming eurozone and U.S. economic reports, which could shift ECB and Fed policy expectations.

GBP/USD Influenced by Risk-Off Flows and Gilt Yields

Meanwhile, GBP/USD fell 0.36%, influenced by risk-off flows and profit-taking from Tuesday's highs. A significant rise in gilt yields contributed to the decline, alongside a sharp drop in the FTSE. The BoE is expected to cut rates less aggressively than the ECB, providing some relative support for the pound.

Broader Currency Market Outlook

The broader currency market outlook is characterized by ongoing volatility driven by economic data and geopolitical developments. The dollar is likely to remain supported by safe-haven flows and reduced Fed rate cut expectations. The euro could see further declines if the ECB moves forward with rate cuts amid strong economic indicators. The yen's trajectory will be influenced by U.S.-Japan yield differentials and potential BoJ interventions. The pound's performance will hinge on UK economic data and BoE policy signals, while risk-sensitive currencies like the Australian dollar may remain under pressure amid global risk-off sentiment and geopolitical tensions. The market will closely monitor these dynamics to navigate the complex landscape of currency movements in the near term.

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