US Dollar Slips After PCE Inflation Data Eases Fed Rate Hike Expectations

The U.S. dollar weakened on Thursday, ending its six-day winning streak after the latest U.S. inflation data met market expectations and slightly reduced concerns about additional Federal Reserve interest rate hikes. The U.S. Dollar Index (DXY), which measures the greenback against six major currencies, fell 0.2% to 101.43 during late trading as investors reacted to the latest Personal Consumption Expenditures (PCE) price index report.

The May core PCE price index, the Federal Reserve's preferred inflation gauge, increased by 0.3% month-over-month and 3.4% year-over-year, matching economists' forecasts and rising modestly from April. Meanwhile, headline PCE inflation climbed 0.4% monthly and 4.1% annually, slightly below expectations for the monthly figure but in line on an annual basis. Despite the softer reading, both headline and core inflation remain well above the Fed's 2% target, highlighting persistent price pressures across the U.S. economy.

Investor expectations for monetary policy have shifted significantly in recent weeks. Earlier concerns about rising inflation were fueled by supply disruptions caused by tensions in the Middle East, particularly around the Strait of Hormuz, which sent global oil prices sharply higher. Those inflation fears prompted several central banks, including the Federal Reserve, to adopt a more hawkish stance. Under Chair Kevin Warsh, the Fed's latest projections indicated that at least half of policymakers expect interest rate increases before the end of the year.

However, easing geopolitical tensions following an interim peace agreement between the United States and Iran have helped restore shipping through the Strait of Hormuz, leading to lower oil prices. As energy costs declined, investors became more optimistic that inflation pressures may have peaked. According to the CME FedWatch Tool, the latest inflation report slightly reduced market expectations for future Fed rate hikes while increasing the probability that policymakers will keep interest rates unchanged in upcoming meetings.

KPMG Chief Economist Diane Swonk noted that while the latest inflation figures suggest the Middle East conflict intensified price pressures, inflation had already shown signs of becoming persistent before the geopolitical crisis. She believes service-sector inflation remains a concern and continues to support expectations for two additional Federal Reserve rate hikes later this year.

In the foreign exchange market, the euro and British pound strengthened against the weaker U.S. dollar. EUR/USD rose 0.1% to 1.1370, while GBP/USD gained 0.2% to 1.3191. The Japanese yen remained relatively stable, with USD/JPY trading around 161.80, still above the key 160 level that has previously prompted intervention by Japanese authorities.

The Australian dollar also recovered after stronger-than-expected employment data. Australia's economy added 40,300 jobs in May, marking the largest monthly increase in five months, although April's figures were revised lower. While the resilient labor market supports the country's economic outlook, analysts believe the data is unlikely to significantly alter the Reserve Bank of Australia's policy direction. Capital Economics continues to expect that persistent inflation could still lead to one final precautionary interest rate hike by the RBA later this year.