Dollar Treads Water As Markets Reassess Rate Bets; ECB Eyed

The U.S. dollar struggled versus its major rivals on Monday as softening inflation expectations prompted a reassessment of the prospects for aggressive interest rate hikes but volatile markets cushioned a broader decline.

Aggressive rate hike bets have boosted the dollar with an index rising to a near two-decade high of 105.79 earlier this month. But with some high-frequency data indicators showing economic momentum starting to cool and a broader drop in commodity prices, investors are becoming cautious.

"The dollar index is trading towards the lower end of its recent trading range suggesting some vulnerability to further weakness," said Shaun Osborne, an analyst at Scotiabank, said.

"We feel the broader dollar rally will struggle to extend significantly but losses are liable to remain limited unless or until a more significant bearish catalyst emerges."

Against its rivals, the dollar edged 0.2% lower to 103.86. Earlier this month, it hit 105.79, its highest since late 2002.

While slowing growth concerns have weighed on sentiment, lower inflation expectations, chiefly through falling commodity prices have also eased the pressure for higher rates.

For example, copper is on track for its largest monthly decline since the pandemic-fuelled selloff in March 2020. Oil prices are set to see a monthly decline for the first time this year.

Falling commodity prices have weighed on expectations of where U.S. interest rates will peak next year. Higher terminal pricing of benchmark interest rates has been a key support for the dollar but that source of strength has faded in recent days.

Futures pricing shows traders now anticipating the U.S. Federal Reserve's benchmark funds rate stabilising around 3.5% from March next year, a pullback from pricing in rates zooming to around 4% in 2023.

"Broadly speaking, markets have priced a lower and earlier terminal rate from the Fed as a result, which is shaving some of the dollar's appeal from a yield differential basis," said Simon Harvey, head of FX analysis at Monex Europe.

The euro led gainers versus the dollar as the European Central Bank's annual forum in Sintra got underway with ECB President Christine Lagarde and Federal Reserve Chair Jerome Powell both attending the meeting. Markets will watch for any signs of future policy moves.

The euro is up 0.2% at $1.0580.

Commodity currencies came under pressure on Monday as data showed profits at China's industrial firms shrank again, albeit at a slower pace, in May after a sharp fall in April.

Elsewhere, Russia's rouble weakened in the interbank market as Russia headed for its first sovereign default since the Bolshevik revolution a century ago.

Cryptocurrencies solidified gains, with the world's biggest cryptocurrency Bitcoin up 1.4%, trading at $21,170.88 after falling as low as $17,588.88 earlier this month.