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Watch the U.S. dollar. Will Fed follow suit after Australia’s surprise rate hike?

Sometimes a pause is just a pause.

That message was reinforced by Australia’s central bank Tuesday, when it unexpectedly delivered a second straight quarter percentage point interest rate increase that took its official lending rate to an 11-year high. The May and June hikes came after just a one-month pause in the rate hike cycle in April.

The Reserve Bank of Australia said inflation remained too high and removed language from its statement saying that inflation expectations were well-anchored.

See: Aussie bond yields and dollar rise after central bank delivers another surprise rate hike

Australia’s short-lived pause comes ahead of a Federal Reserve policy meeting next week that’s expected to see U.S. monetary policy makers take a rest after a breakneck series of rate increases that have lifted the fed-funds rate from near zero to 5% to 5.25% since March 2022.

Fed officials have indicated that a pause is justified, while emphasizing that skipping a rate increase in June doesn’t mean they can’t deliver a hike at a later date.

MarketWatch Interview: Fed’s Harker says skipping June rate hike is returning to normalcy

Fed-funds futures traders have priced in a probability of around 23% for a quarter percentage point rate hike in June, down from nearly 67% a week ago, according to the CME FedWatch tool, but they still see a better than 60% chance that rates will rise by the end of the Fed’s July meeting.

Fed policy makers meet next week. The spotlight on Wednesday will move to the Bank of Canada, which left rates unchanged at its two policy meetings

A 25 basis point rate hike Wednesday by the Bank of Canada — seen as a 43% probability in the money market — “would probably cause ripples across core bond markets around the world and could keep the dollar bid on the view that the Fed might be closer to hiking than first thought,” said Chris Turner, global head of markets at ING, in a note. “Let’s see.”

On Tuesday the U.S. dollar bounced back from earlier weakness, with the ICE U.S. Dollar Index
a measure of the currency against a basket of six major rivals up 0.2%. The index hit a roughly 2-decade high last fall but then tumbled sharply before regaining its footing. It’s now up around 0.7% for the year to date.

U.S. stocks were putting in a mixed performance, with the S&P 500

ticking up 0.1%, while the Dow Jones Industrial Average

fell 42 points, or 0.1%.

Turner said bears will likely remain reluctant to rebuild short bets on the dollar until next week’s “double event risk” posed by the release of the May consumer-price index on June 13 and the Fed policy decision on June 14 are overcome.

Skeptics contend a pause for the Fed will likely mark the end of the rate cycle, despite the RBA’s counterexample.

It’s easy to understand why central bankers don’t like to say categorically say they’re finished raising rates, said Steve Barrow, head of G-10 strategy at Standard Bank, in a Tuesday note.

After all, if they’re subsequently forced to into a hike by the data or the performance of asset prices, they lose credibility. But for most central banks, the reality is that they are finished with hikes, he said.

Barrow said another problem with attempts to “fine-tune” monetary policy is that it leads central bankers to suggest that rates can rise again on the basis of just a few numbers, like the unemployment rate of CPI.

The problem is that heavy reliance on certain pieces of data, such as inflation or unemployment runs up against the risk of swift revisions to the data, particularly in the case of employment, and also against the possibility that any data surprise just proves to be an outlier.

“Don’t get us wrong. We are not totally against the idea of making any tweaks to policy after a pause has been declared. Where we do take issue is when the market — and perhaps policy makers as well — think that new rates hikes could come almost immediately after a pause, and ‘only’ because a few pieces of data lie outside market and policy maker expectations,” he wrote.

For the Fed, that would mean that if policy makers pause this month they won’t quickly lift rates again just because of a few bad pieces of data. Instead, the hope is that it would take an accumulation of evidence, probably over several months, that shows policy is insufficiently tight, before the Fed begins to hike again, he said.

The Fed is different than the RBA, Barrow wrote, because it seems to put more faith in the idea of a pause than Australian policy makers, and, second because it has to be aware that monetary policy flip-flopping between pause and rate hikes can unsettle global sentiment, economies and financial markets just as it can fracture the local economy and local markets.    

This story originally appeared on Marketwatch

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