Speculation of Tighter Fed Policy Boosts the Dollar and Hammers Gold

The dollar index (DXY00) on Wednesday rose by +0.20%.  The dollar added to its week-long surge on Wednesday and posted a new 13-month high.  The dollar continues to benefit from carryover support from last Wednesday, when the FOMC’s hawkish stance suggested higher interest rates later this year.  The dollar fell back from its best level after May’s new home sales unexpectedly fell to a 4-month low.

The US Q1 current account balance was -$225.8 billion, a larger deficit than the -$208.9 billion expected.

US May new home sales unexpectedly fell -7.3% m/m to a 4-month low of 580,000, weaker than expectations of an increase to 640,000.

The swaps markets are discounting the odds at 34% for a +25 bp rate cut hike at the next FOMC meeting on July 28-29.

EUR/USD (^EURUSD) fell by -0.25% on Wednesday and posted a fresh 1-year low.  The dollar’s strength on Wednesday weighed on the euro.  Also, the euro is falling amid negative carryover from Monday, after ECB President Lagarde’s dovish comments reduced the chances of additional ECB rate hikes, when she said she sees no need for a more forceful ECB response to the US-Iran war. 

However, the euro recovered from its worst level on Wednesday on hawkish comments from ECB Executive Board member Isabel Schnabel, who said, “From today’s perspective, we will need to continue raising interest rates in order to bring inflation back to our target of 2% in the medium term.” Also, Wednesday’s Eurozone economic news was supportive of the euro, as the German IFO business confidence index rose more than expected. 

The German Jun IFO business confidence index rose +0.6 to 85.6, stronger than expectations of 85.5.

The markets are discounting a +9% chance for a +25 bp rate hike by the ECB at its next policy meeting on July 23.

USD/JPY (^USDJPY) on Wednesday rose by +0.16%.  The yen moved lower on Wednesday but remained above Monday’s 23-month low against the dollar.  The yen remains under pressure amid concerns that the BOJ is falling behind the curve in normalizing monetary policy.  Last week, BOJ Deputy Governor Uchida said that the BOJ will assess the impact of rate hikes on the economy, signaling it will move at a glacial pace on policy tightening. 

Losses in the yen were contained on Wednesday amid hawkish comments from BOJ Governor Kazuo Ueda, who said, “With underlying inflation moving toward 2% and financial conditions remaining accommodative, we expect to continue increasing the interest rate and adjusting the degree of monetary accommodation in response to economic activity, prices, and financial conditions.”

The risk of intervention in currency markets to support the yen is rising after Japanese Finance Minister Satsuki Katayama said she spoke with US Treasury Secretary Scott Bessent on Tuesday, and they agreed to take “bold” steps on currencies if needed, and that the nations are increasingly “aligned” on foreign-exchange policy.  With the yen firmly above 160 per dollar, intervention risks have increased, as Japanese authorities have intervened in the forex market several times in the past when the yen reached that level. 

Japan May PPI services prices were unchanged from April at +3.3% y/y, right on expectations and the highest in 14 months.

The markets are discounting a +2% chance of a +25 bp BOJ rate hike at the next policy meeting on July 31.

August COMEX gold (GCQ26) on Wednesday closed down -140.60 (-3.39%), and July COMEX silver (SIN26) closed down -3.983 (-6.42%).

Gold and silver prices plunged on Wednesday, adding to this week’s sharp decline, with gold posting a 7.5-month low and silver posting a 6.5-month low.  Wednesday’s rally in the dollar index to a 13-month high is bearish for metals. Losses in precious metals accelerated on Wednesday when ECB Executive Board member Isabel Schnabel said she sees the need for additional ECB rate hikes to bring inflation back down to 2%.  Precious metals are also being weighed down by negative carryover from last Wednesday, when the FOMC signaled higher interest rates this year, sparking liquidation of long precious metals positions. 

Precious metals found some support from Wednesday’s fall in WTI crude oil prices to a 3.5-month low, which has eased inflation expectations and could prompt global central banks to ease monetary policy, a bullish factor for precious metals.  In addition, precious metals have safe-haven demand amid political uncertainty in the UK following Keir Starmer’s announcement on Monday that he would step down as Britain’s prime minister.   

Recent fund liquidation of precious metals is bearish for prices, as long holdings in gold ETFs fell to a 7.5-month low last Wednesday, after reaching a 3.5-year high on February 27.  Also, long holdings in silver ETFs fell to an 11-month low last Friday from the 3.5-year high posted 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 +320,000 ounces to 74.96 million troy ounces in May, the largest monthly increase in 17 months, and the nineteenth consecutive month the PBOC boosted its gold reserves.