Dollar Drips Downward as Market Prices in Pause

A very quiet news night in the currency markets nevertheless saw the dollar extend its slide as traders continued to price in the prospect of a Fed pause at the next FOMC meeting in August. The key tipping point to market sentiment was yesterday's lackluster Beige Book report which confirmed Chairman Bernanke's testimony last week that the US economic demand was slowing while inflationary pressures outside of the energy sector remained muted. As a result the fed fund futures declined to 43% probability as the market lowered the chances for another 25bp hike to below even money.

Fed's greatest concern appears to be the housing market which is showing ever greater signs of a slowdown. Today's New home sales report may seal the deal for a pause in rates if, as expected, it registers a near 10% decline from the month prior. Yet on the flip side, many analysts argue that inflationary pressures are not nearly as benign as the Fed chairman made them out to be and Friday's upcoming PCE deflator data - the Fed favorite measure of inflation - may force monetary policy makers to tighten once more despite the threat to US consumer demand that such a move would produce.

Overall, the economic picture remains muddy and the markets may not able to gauge the true intention of Fed's actions until the Non-Farm payroll report a week from next Friday. While housing demand has clearly cooled, it is unlikely to crater unless employment growth slows materially. As long as US economy continues to produce jobs and moderate wage growth, US consumer demand should remain steady and therefore able to absorb more monetary tightening. Should employment contract however, the dollar is likely to see a sustained period of serious weakness as the primary reason for dollar bullishness in the currency market - the greenback's ever rising interest rate yield - will cease to exit.