The U.S. dollar weakened broadly on Tuesday after softer-than-expected PPI data reinforced expectations of cooling inflation and increased the likelihood of additional Federal Reserve rate cuts by year-end. Sterling was the standout performer, climbing more than 1% against the dollar to a high of 1.3557, supported by both broad USD weakness and speculation that the UK's next Prime Minister will appoint a fiscally responsible Chancellor. Meanwhile, the Bank of Canada held its overnight rate at 2.25% as expected, signaling confidence in a second-quarter recovery but maintaining a data-dependent stance.
Fed Officials Strike Cautiously Hawkish Tone
New York Fed President John Williams struck a moderately hawkish but cautiously optimistic tone in his remarks, stressing that restoring inflation to the Fed's 2% target remains the central priority. He noted that inflation is still too high at around 4% but said there are encouraging signs that it has peaked, with the latest CPI report indicating movement in the right direction. Williams expects inflation to slow to about 3.25% by year-end before gradually returning to 2% in 2028. He described the economy and labor market as resilient and stable, forecasting trend-like GDP growth and a gradual decline in unemployment. While acknowledging risks from Middle East supply disruptions and uncertainty surrounding AI-driven investment, he said the U.S. economy has so far absorbed those challenges well. Williams avoided providing any guidance on the path of interest rates, reiterating that the Fed has moved away from forward guidance and that rates should eventually move lower once inflation is sustainably back at 2%.
Fed Chair Kevin Warsh, testifying before the Senate Banking Committee, largely repeated themes from his House testimony, maintaining a mildly hawkish stance. He said recent inflation data is an imperfect gauge of underlying price pressures and stressed that inflation remains the weaker side of the Fed's dual mandate, even as the labor market is in good shape. Warsh said the Fed is prepared to adjust both interest rates and its balance sheet if needed to keep inflation under control and reiterated that the balance sheet should ultimately be as small as practical. He also highlighted the surge in AI investment as a major driver of business spending and economic growth, noting that while AI may cause one-time price increases and some job displacement, it will ultimately create jobs and boost productivity. The testimony offered little that was new and was consistent with his prior comments.
Bank of Canada Holds Rate, Sees Solid Q2
The Bank of Canada left its overnight rate unchanged at 2.25%, as widely expected, while signaling increased confidence that the economy is beginning to recover after a weak start to the year. Policymakers said growth appears to have resumed in the second quarter at an annualized pace of roughly 2.5%, with the expansion broadening beyond a few sectors. While labor market conditions remain soft and housing activity has been subdued, the Bank noted signs of stabilization in housing and expects business investment to improve as companies adapt to ongoing uncertainty surrounding the USMCA trade framework. On inflation, the Bank acknowledged that headline price pressures have risen in the near term, largely due to higher gasoline prices, refinery margins, and the weaker Canadian dollar. However, it emphasized that underlying inflation remains close to the 2% target and is expected to ease gradually over time. The Governing Council reiterated that it will continue to assess incoming economic data and stands ready to adjust monetary policy if needed. Notably, the Bank removed earlier language emphasizing that it would look through the inflationary effects of geopolitical tensions, instead adopting a more balanced tone.
In the press conference, Governor Tiff Macklem struck a cautiously optimistic tone, saying the economy appears to have regained momentum in the second quarter, with growth looking "pretty solid." While he acknowledged there are still questions about how durable the recent improvement will prove to be, he added that the Bank believes the recovery is sustainable. Macklem emphasized that policymakers will continue to evaluate incoming data before drawing firm conclusions, reinforcing that future policy decisions will be made one meeting at a time rather than following a predetermined path. On inflation, he warned that if oil prices were to rise sharply again and begin feeding more broadly into inflation, the Bank would likely need to respond.
Currency and Commodity Moves
The euro also advanced against the dollar as lower U.S. yields supported the pair, while the New Zealand dollar and Australian dollar posted solid gains. The Canadian dollar strengthened modestly after the BOC decision. In commodities, crude oil futures settled at $79.60, up $0.26 or 0.33%, amid renewed geopolitical tensions after U.S. military strikes on Iran and ongoing uncertainty in the Middle East. The White House is reportedly weighing an additional extension of Jones Act waivers as the renewed conflict stirs price fears. Weekly EIA crude oil inventory showed a draw of 1.692 million barrels, smaller than the expected 2.594 million barrel draw. U.S. Treasury yields moved lower across the curve, with the 2-year yield falling 5.2 basis points to 4.140%, the 10-year yield down 3.7 basis points to 4.551%, and the 30-year yield slipping 1.1 basis points to 5.083%.