Dollar's Hawkish Shift Faces First Test as Warsh's Repricing Looms Large
The US dollar is trading lower on Monday, but it's not necessarily a sign that its next move will be downward. The more significant development occurred on Friday, when Federal Reserve Chair Kevin Warsh stated that the labor market remains consistent with full employment, while inflation is still too high. This caused markets to reassess their expectations of a September Fed hike, pushing the probability from around 35% to 64%. While the dollar index did give back some of this gain on Monday, trading around 99.5, it's still seen as consolidation rather than a reversal of Friday's move.
Treasury yields remain elevated at 4.76%, and oil prices have climbed above $90 per barrel following the resumption of direct US-Iran military exchanges. This geopolitical shock can increase demand for safe-haven assets like the dollar, making it a potential beneficiary. However, the market's reaction to these developments will be put to the test on Tuesday with speeches from Fed Governor Michael Barr and the release of important employment data.
Barr's speech is particularly noteworthy as he has previously expressed concerns about inflation and the impact of higher energy prices on economic activity. If he continues to emphasize labor-market vulnerability and patience, some of Friday's hawkish repricing could cool. However, if his balance shifts more decisively toward inflation, it would strengthen the signal for another Fed hike.