• Dollar strengthens on ADP and US debt downgrade
• ISM non-mfg. PMI the next test for dollar traders
• BoE expected to hike by 25bps; Will it sound hawkish?
• Wall Street slumps after US rating cut

The US dollar continued gaining ground on Wednesday and it appears to be holding firm today as well.

The greenback has been slowly gaining ground since the beginning of the day on Wednesday, perhaps due to safe-haven inflows after the unexpected downgrade of the US government’s top credit rating, accelerating its rally after the ADP employment report revealed that the private sector gained many more jobs than anticipated.

The notion that the downgrade may have enhanced the dollar’s safe-haven appeal is supported by the slide in equities and Treasury bonds, with the latter being evident by the rebound in yields. Despite pulling back after the news was published, the 10-year yield rebounded later in the day to hit levels last seen in early November.

Having said all that though, the market moves are far from suggesting panic, perhaps as no one is seriously considering the possibility of the US government failing to proceed with its debt payments.

Today, dollar traders may shift their focus to the ISM non-manufacturing PMI for more evidence as to how the US economy has fared in July. Anything bolstering the soft-landing narrative could add extra fuel to the greenback’s latest recovery, but for investors to start pricing higher interest rates for longer, a strong employment report on Friday may be needed.

Ahead of the ISM non-manufacturing survey, traders of the British pound will have to digest the Bank of England interest rate decision. Following the larger than expected slowdown in UK inflation for June and the soft PMIs for July, investors have become increasingly convinced that the Bank will need to proceed with a 25bps increment at this gathering, instead of another double hike.

According to the UK overnight index swaps (OIS), market participants assign a 63% probability for a quarter-point increase, with the remaining 37% pointing to 50bps. Therefore, should the Bank proceed with 25bps, those expecting more may be disappointed and the pound could initially slide.

However, considering that underlying inflation in the UK is still more than triple the BoE’s objective, allowing traders to believe that the end of this tightening crusade is drawing closer may be an unwise choice. Ergo, officials may have to sound hawkish and highlight the need for more action, which could help the pound rebound and perhaps extend its prevailing uptrend for a while longer.

For sterling to suffer post the meeting, the BoE may need to signal that they are also getting closer to the finish line. Now, in the case of another double hike, the currency is likely to shoot higher instantly.

Flying over to Japan, the 10-year Japanese Government Bond (JGB) yield hit a new nine-year high yesterday, with investors insisting to test the Bank of Japan’s tolerance after policymakers announced a more flexible strategy to control their yield curve. That said, the yen was little changed yesterday, taking a breather after three days of steep losses. Today, it is on the back foot again.

Wall Street slumped yesterday on the back of the US debt’s downgrade, with the Nasdaq losing more than 2%. Although the slide is far from suggesting a major trend reversal, if incoming US data, and especially the US jobs report on Friday, forces market participants to raise their implied Fed rate path, the correction may continue for a while longer.

That said, apart from changes in the macroeconomic and monetary policy outlooks, equity traders will probably pay special attention to earnings results by Amazon and Apple, which are scheduled to be released after the closing bell today.

Gold also suffered losses yesterday, despite the risk-averse environment. With US Treasury yields rising, it seems that investors are considering the US dollar as a better safe-haven alternative. Should the dollar stay on the front foot for the remainder of the week, the precious metal may be poised to test the $1,910 zone soon, near the low of July 7.