Reduced Fed Rate Hike Expectations Undercut the Dollar

The dollar index (DXY00) fell to a 2.25-month low on Monday and finished down -0.04%.  The dollar extended last week’s losses on Monday after a raft of weaker-than-expected US economic news dialed back expectations of tighter Fed policy.  The chance of a Fed rate hike next month has dropped to 37% from about 75% in late July.

The dollar is also being undercut by reduced safe-haven demand as President Trump appears to have given up on plans for any new major military attack on Iran for the time being, favoring economic pressure instead.  Treasury Secretary Bessent said last Friday that the administration will soon announce unprecedented economic measures against Iran that "have never been seen in the history of economic isolation of a country." Yet, the military conflict continues as there were reports that Iran attacked two Abu Dhabi oil vessels in the Strait of Hormuz last Thursday night.

Dollar losses were limited on Monday amid some better-than-expected US economic news.  The Aug Empire manufacturing survey showed general business conditions unexpectedly rose +5.0 to a 4.5-year high of 20.6, stronger than expectations of a decline to 10.0.  Also, the Aug NAHB housing market index unexpectedly rose +1 to 35, stronger than expectations of a decline to 33. In addition, Monday’s +2% jump in WTI crude oil to a 3-week high boosted inflation expectations and may prompt the Fed to tighten monetary policy, a supportive factor for the dollar. 

The markets are discounting a 37% probability of a +25 bp rate hike at the next FOMC meeting on September 15-16.

EUR/USD (^EURUSD) rose to a 2-month high on Monday and finished up by +0.02%.  Dollar weakness on Monday gave the euro a boost.  Also, higher European government bond yields strengthened the euro’s interest rate differentials as the 10-year German bund yield rose to a 15-year high on Monday at 3.223%.  The euro fell from its best level after crude oil prices rallied more than +2% to a3-week high, which is bearish for the Eurozone economy and the euro as Europe imports most of its energy. 

The markets are discounting a 94% chance of a +25 bp ECB rate hike at its next policy meeting on September 10.

USD/JPY (^USDJPY) rose by +0.17% on Monday.  The yen gave up an early advance on Monday and dropped to a 2-week low against the dollar after crude oil prices rallied more than +2% to a 3-week high, a bearish factor for Japan’s economy and the yen, as Japan imports more than 90% of its energy.  The yen was also under pressure after Monday’s economic news showed Japan’s Q2 GDP grew less than expected, a negative factor for the yen.  In addition, higher T-note yields on Monday were bearish for the yen. 

The yen initially moved higher on Monday amid higher Japanese government bond yields, which strengthened the yen’s interest rate differentials.  The 10-year Japan JGB bond yield rose to a 30-year high of 2.938% on Monday. 

The yen has underlying support from increased expectations of a BOJ rate hike after Bloomberg reported last Thursday that Japanese Prime Minister Sanae Takaichi's government supports a BOJ rate hike in either September or October.  The government favors a rate hike to support the yen and prevent inflationary pressures stemming from the weak yen.  Finally, the yen has ongoing support from the recent coordinated US-Japan intervention and fears that further intervention might be forthcoming if the yen remains weak.

Japan Q2 GDP rose +1.1% (q/q annualized), weaker than expectations of +2.0%, as Q2 private consumption was unchanged q/q, weaker than expectations of +0.4% q/q.  Also, Q2 business spending unexpectedly fell -1.2% q/q, weaker than expectations of +0.5% q/q.  The Q2 deflator rose +2.6% y/y, stronger than expectations of+2.3% y/y.

Japan's Jun tertiary industry index fell -0.2% m/m, stronger than expectations of -1.0% m/m.

Japan's June industrial production was revised upward by +0.6 to 1.9% m/m from the previously reported +1.3% m/m.

The markets are discounting a 74% 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 range of 3.50%-3.75%.

October COMEX gold (GCV26) closed up +36.40 (+0.83%) on Monday, and September COMEX silver (SIU26) closed up +1.123 (+1.72%).

Precious metals prices settled higher on Monday, amid the fall in the dollar index to a 2.25-month low. Precious metals also have support from recent weaker-than-expected US economic news that dampened expectations for a Fed rate hike.  Monday’s weakness in stocks also boosted some safe-haven demand for precious metals.

Gains in precious metals were limited on Monday amid higher crude oil prices, which may persuade global central banks to tighten their monetary policies, a bearish factor for precious metals.

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 the Aug 7 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.