Dollar Rallies on Strength in Crude and the US Economy

The dollar index (DXY00) on Wednesday rallied to a 1.75-month high, finishing up by 0.31%.  The dollar moved higher on Wednesday, supported by a +2% increase in WTI crude oil prices, which lifts inflation expectations and may prompt the Fed to tighten monetary policy, a bullish factor for the dollar. 

Gains in the dollar accelerated on Wednesday on stronger-than-expected US economic reports on May ADP employment, the May ISM services index, and Apr factory orders, which are hawkish for Fed policy.  In addition, escalation of Middle East tensions is boosting some safe-haven demand for the dollar after US forces intercepted Iranian ballistic missiles and drones aimed at neighboring countries and struck an Iranian command center in response. 

The dollar posted its high on Wednesday afternoon on a hawkish Fed Beige Book that reported slight to moderate economic growth across most Fed districts through May 27, with employment little changed and most of the 12 Fed districts reporting higher inflation than in the previous report.

The US May ADP employment change rose 122,000, slightly stronger than expectations of 120,000 and the biggest increase in 16 months.

The US May ISM services index rose +0.9 to 54.5, stronger than expectations of 53.8.

US Apr factory orders rose +4.8% m/m, stronger than expectations of +4.6% m/m and the largest increase in 11 months.

New York Fed President John Williams said, "Monetary policy is exactly in the right place.  I don't see any need to raise or lower interest rates right now."

The swaps markets are discounting the odds at 3% for a +25 bp rate cut hike at the next FOMC meeting on June 16-17.

EUR/USD (^EURUSD) on Wednesday fell by -0.27%.  The euro was under pressure on Wednesday from a stronger dollar.  Also, Wednesday's more than +2% jump in crude oil to a 1.5-week high is bearish for the Eurozone economy and the euro, as Europe imports most of its energy.

Wednesday's Eurozone economic news was supportive of the euro after Eurozone April producer prices posted their fastest pace of increase in more than three years, and the Eurozone May S&P composite PMI was revised upward.

Eurozone Apr PPI rose +4.9% y/y, right on expectations and the fastest pace of increase in more than 3 years.

The Eurozone May S&P composite PMI was revised upward by +1.0 to 48.5 from the previously reported 47.5.

The markets are discounting a +98% chance for a +25 bp rate hike by the ECB at the next policy meeting on June 11.

USD/JPY (^USDJPY) on Wednesday rose by +0.07%.  The yen fell to a 1-month low against the dollar on Wednesday after crude oil prices rose by more than 2% to a 1.5-week high, which is bearish for the Japanese economy and the yen, as Japan imports most of its energy. Also, higher T-note yields on Wednesday were bearish for the yen.  Losses in the yen were limited amid hawkish comments from BOJ Governor Kazuo Ueda, which have boosted the chances of a BOJ interest rate increase later this month.  

BOJ Governor Kazuo Ueda said that should the economy evolve in line with the BOJ's forecasts, which see the Mideast turmoil calming and inflation reaching its 2% target, "I think the bank will continue to raise the policy rate at an appropriate pace."

The markets are discounting a +90% chance of a +25 bp BOJ rate hike at the next policy meeting on June 16.

August COMEX gold (GCQ26) on Wednesday closed down -53.00 (-1.17%), and July COMEX silver (SIN26) closed down -1.862 (-2.46%).

Gold and silver prices retreated on Wednesday after the dollar index rallied to a 1.75-month high.  Also, Wednesday's +2% jump in crude oil prices raised inflation expectations and may force the world's central banks to tighten their monetary policies, a bearish factor for precious metals.  In addition, higher global bond yields on Wednesday weighed on precious metals prices. 

Hawkish comments from BOJ Governor Kazuo Ueda boosted the chances of a BOJ rate hike later this month and also undercut precious metals when he said the risks of higher inflation call for higher interest rates.  Precious metals added to their losses on Wednesday on stronger-than-expected US economic reports on May ADP employment change, May ISM services index, and Apr factory orders, and the Fed Beige Book, which are hawkish for Fed policy. 

Recent fund liquidation of precious metals is bearish for prices, as long holdings in gold ETFs fell to a 5.5-month low on March 31 after climbing to a 3.5-year high on February 27.  Also, long holdings in silver ETFs fell to a 9.5-month low on May 5 after rising to a 3.5-year high on December 23.

Strong central bank demand for gold is supportive of gold prices, following news that bullion held in China's PBOC reserves rose by +260,000 ounces to 74.64 million troy ounces in April, the largest monthly increase in a year and the eighteenth consecutive month the PBOC has boosted its gold reserves.