Dollar Rebounds After U.S. Labour Costs Deliver "Deeply Unwelcome" News to the Fed

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A measure of wages that is closely watched by the Federal Reserve has added fresh evidence to a docket showing inflationary pressures in the U.S. are increasing.

"U.S. labour costs rose by 1.2% in the first quarter versus the 1.0% expected, pushing the two-year US Treasury yield to a five-month high above 5.00% and driving the US dollar index up by around 0.3%," says Kyle Chapman, FX Markets Analyst at Ballinger Group.

The Pound to Dollar exchange rate relinquished earlier gains and was a third of a per cent lower on the day at 1.2522 after the U.S. Bureau of Labor Statistics also revealed Employment Wages rose 1.10% q/q in the first quarter. Employment Benefits were up by 1.10% q/q from 0.70% previously.

The USD rebound trounced supportive Eurozone data from earlier in the day to send the Euro-Dollar exchange rate to 1.07. (-0.17% d/d).

Karl Schamotta, Chief Market Strategist at Corpay says relative to a year earlier, wages and benefits have risen roughly 4.2%, helping to lift consumer demand and business investment across an increasingly exceptional US economy.

"Bond yields and the US dollar are advancing on the print, and hawkish guidance risks heading into tomorrow’s Federal Reserve announcement are rising. Simply put, the central bank cannot deliver its long-awaited pivot until labour markets and inflation pressures ease relative to today’s superheated levels," says Schamotta.

"The downshift in growth in employment costs, both wages and benefits has slowed. This likely will prove temporary, given the very clear message from the low and falling quits rate, but the Fed is uninterested in forecasts and this report will be deeply unwelcome," says Ian Shepherdson, Chairman and Chief Economist at Pantheon Macroeconomics.

Market expectations for the first rate cut have now retreated to December, confirming a measly 25 basis points of cuts are anticipated for the year. The market entered 2024 with 150bps of cuts anticipated. "This development is unwelcome for consumers struggling under the weight of increased borrowing costs," says Matt Mayerle, an analyst at CreditNinja.

The Federal Reserve will deliver its next interest rate decision and guidance on Wednesday, with economists expecting the central bank to announce the prospect of interest rate cuts in the near term has diminished. It will likely upgrade its inflation forecasts and other economic projections, which can underscore recent FX market trends that have tended to favour the Dollar.

Chapman explains that the surge in labour costs so far this year simply adds another macro gauge to the roster of hot U.S. inflationary data at this point, and should Fed Chair Jerome Powell to retain caution about cutting rates in tomorrow’s press conference.

"The trajectory is unidirectional across all of the inflationary indicators, and the report certainly casts doubt on whether rate cuts will come at all this year - more and more traders will begin to hedge against the prospect of further hikes. The Fed evidently still has some way to go to rein in embedded inflationary pressures," he says.

The details of the report show the strength was primarily led by the government sector, where wage and salary growth rose from 4.7% year-on-year to 5% while for the private sector, wages and salaries remained at 4.3% YoY with overall compensation continuing to grow 4.1%.