Dollar Ends Higher Despite Dovish US CPI Report

The dollar index (DXY00) on Wednesday rose by +0.20 (+0.20%), recovering from early losses tied to the dovish US CPI report and reduced expectations for a Fed rate hike.  The dollar rebounded higher as T-note prices closed just mildly higher, weighed down by the fact that Wednesday's 10-year T-note auction produced the highest yield since the 2007 financial crisis.  Investors have demanded higher Treasury yields, partially due to Fed Chair Warsh's reduced guidance and uncertainty about the Fed's inflation-fighting resolve.

Wednesday's July US CPI report was exactly in line with market expectations.  On a year-on-year basis, the July CPI eased to +3.4% y/y from June's +3.5%, and the core CPI eased to +2.5% from June's +2.6%.  On a month-on-month basis, the July CPI rose +0.1% m/m, and the core CPI rose +0.2% m/m.

The July core CPI report of +2.5% y/y matched the 5.5-year low posted earlier this year but remained above the Fed's 2% inflation target.  The nominal CPI remains elevated at +3.4%, well above the 5.5-year low of +2.3% posted last year.

The risk of a renewed flare-up across the Middle East remains high, which is providing safe-haven demand for the dollar. There is little sign of any progress in US-Iran talks to open the Strait of Hormuz.  Also, a US Navy helicopter fired two missiles at a cargo vessel on Tuesday that the US said was trying to call at an Iranian port, in violation of the US blockade on Iran's ports.

The markets are discounting a 40% probability of a +25 bp rate hike at the next FOMC meeting on September 15-16, down from 51% on Tuesday.

EUR/USD (^EURUSD) fell -0.19% on dollar strength.

The markets are discounting an 88% chance of a +25 bp ECB rate hike at its next policy meeting on September 10.

USD/JPY (^USDJPY) rose +0.13%, with the yen failing to get much benefit from the dovish US CPI report and reduced expectations for a Fed rate hike.  The yen has near-term support amid signs the US might continue joint intervention in the forex market in support of the yen.  Kyodo reported on Monday that BOJ Governor Kazuo Ueda's strong signal for a BOJ interest rate increase next month was the decisive factor behind the recent coordinated intervention in the yen by Japan and the US.  

The markets are discounting a 63% chance of a +25 bp BOJ rate hike at the September 18 policy meeting. The yen continues to suffer from weak interest rate differentials, with the BOJ's current policy rate of 1.00% well below the Fed's federal funds rate target of 3.50%-3.75%.

October COMEX gold (GCV26) on Wednesday closed up +26.10 (+0.59%), and September COMEX silver (SIU26) closed up +0.0765 (+1.18%).

Gold and silver prices saw support from the dovish CPI report and reduced expectations for a Fed rate hike.  However, precious metals prices gave up some of their early gains as T-note prices faded from the initial CPI bump.  Precious metals prices were undercut by the higher dollar. 

Recent fund liquidation of precious metals is bearish for prices, as long holdings in gold ETFs fell to a 10.25-month low on July 27, after reaching a 3.5-year high on February 27.  Also, long holdings in silver ETFs fell to a 1-year low on July 14 from the 3.5-year high posted on December 23.

Strong central bank demand for gold is supportive of gold prices, following last Friday's news that bullion held in China's PBOC reserves rose by +640,000 ounces to 76.08 million troy ounces in July, the twenty-first consecutive month the PBOC boosted its gold reserves.