Dollar weakens as market expects Fed to 'skip' rate hike

The U.S. dollar weakened in Asian trading on Friday local time amid increasing expectations that the Federal Reserve would "skip" an interest rate hike this month.

The DXY, an index that measures the dollar against six rival currencies, declined by 0.16 percent to 103.48. The index previously lost 0.62 percent on Thursday, its worst daily percentage loss in nearly a month. The U.S. dollar is currently on track to post its worst weekly performance since mid-January, losing 0.73 percent.

Against the dollar, the euro traded flat at $1.0767. The eurozone hit a one-week high of $1.07685 in the previous trading session after the European Central Bank (ECB) chief Christine Lagarde said further monetary tightening was necessary. The market expects the ECB to deliver at least two more rate hikes, each by 25 basis points.

"We have made clear that we still have ground to cover to bring interest rates to sufficiently restrictive levels."

Christine Lagarde, European Central Bank president

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In the forex market, the U.S. dollar traded 0.13 percent lower to 138.65 yen after dropping to a week-low of 138.44 the previous session. The dollar/yen exchange rate tends to track the performance of long-term U.S. Treasury yields, which dipped to a six-month low of 3.57 percent on Thursday evening in Tokyo trading.

Meanwhile, the Australian dollar increased by 0.61 percent to trade at $0.6613, the highest since May 24. Analysts said the primary driver for the Aussie's rally was the Fair Work Commission's decision to raise the country's minimum wage by 5.75 percent starting July 1. According to National Australia Bank head of forex strategy Ray Attrill, the decision increases the market's anticipation of further rate hikes by the Australian central bank.

Possible rate hike pause

The possibility of a rate hike pause in the Fed's June 13-14 meeting boosts the market's risk appetite, leading to the decline in the U.S. dollar value, say analysts. Barclay senior currency strategist Shinichiro Kadota said the Fed's decision would be "data-dependent," meaning that incoming economic data will significantly affect the central bank's policy decision-making.

Fed governor Philip Jefferson said Wednesday that foregoing an interest rate hike at the next policy meeting will allow the central bank to digest more data before deciding if "additional policy firming" is necessary. Later on Thursday, Philadelphia Fed president Patrick Harker also said the central bank should "at least hit the stop button for one meeting."

Analysts said declining manufacturing activity also boosted a case for a rate hike pause. The Institute for Supply Management reported Thursday that the manufacturing purchasing managers' index fell to 46.9 in May from 47.1 the prior month.

The resolution of the U.S. debt ceiling crisis will also put pressure on the dollar's value. The bill to raise the national debt limit has passed Congress, meaning the U.S. can avoid a "catastrophic" default. This situation increases the market's risk appetite, prompting them to place more funds into risk assets.

Soft landing for U.S. economy

There is increasing optimism that the U.S. economy will hit a "soft landing," say analysts. Soft landing is a situation where the economy experiences a slowdown but not to the point of negative growth. On Wednesday, BlackRock CEO Larry Fink said the U.S. economy is resilient, adding that further interest rate hikes will not lead the economy into a "hard landing."

Analysts have pointed out that the U.S. job market remains robust despite the consecutive rate hikes implemented by the Fed. Although the strong job market complicates the Fed's efforts to stabilize prices, analysts say it protects Americans' purchasing power.

Nevertheless, experts warn investors of some potential risks in financial markets. U.S. lawmakers' decision to increase the debt ceiling will prompt the Treasury to raise funds to meet the country's payment obligations. The federal body is expected to pull liquidity from the market by selling its bills.