Dollar Erases Early Gains as Crude Oil and T-note Yields Move Lower

The dollar index (DXY00) fell from a 2.5-week high today and is down by -0.11%.  The dollar gave up an overnight advance and turned lower today when WTI crude oil dropped from a 6-week high and moved lower, which eased inflation expectations, a dovish factor for Fed policy.  The dollar also fell after the Aug ADP employment change rose less than expected, helping knock T-note yields lower. 

The dollar initially moved higher today after escalation of US-Iran hostilities boosted crude oil prices and pushed the 10-year T-note yield to a 2.75-year high, strengthening the dollar’s interest rate differentials.  Overnight losses in stock index futures also boosted demand for dollar liquidity.

The US Aug ADP employment change rose by +38,000, showing a slightly weaker labor market than expectations of +47,000.

US July factory orders rose +0.9% m/m, stronger than expectations of +0.7% m/m.  Also, July factory orders ex-transportation rose +0.6% m/m, stronger than expectations of +0.4% m/m.

WTI crude prices initially rose to a 6-week high today, pushing the dollar higher as fighting intensified between the US and Iran.  The US carried out a second round of strikes in three days overnight, targeting radar systems and mine-laying capabilities along Iran's southern coast.  Iran retaliated with drone and missile attacks on US bases across the Middle East.  However, crude oil prices gave up an overnight advance and turned lower today when US Energy Secretary Wright said that over 17 million bbl of oil went through the Strait of Hormuz on Monday, easing supply concerns. 

The markets are discounting a 63% probability of a +25 bp rate hike at the next FOMC meeting on September 15-16.

EUR/USD (^EURUSD) fell to a 2-week low today and is down by -0.02%.  Early strength in the dollar today weighed on the euro.  However, losses in the euro are limited due to hawkish comments from ECB Governing Council member and Bundesbank President Joachim Nagel, who signaled an ECB rate hike later this month.   Also, the 10-year German Bund yield rose to a 15-year high of 3.395% today, strengthening the euro’s interest rate differentials. 

ECB Governing Council member and Bundesbank President Joachim Nagel warned that "inflation isn't close to our medium-term target" and said, "markets are pricing in a probability of more than 95% that we'll raise interest rates at our September meeting, and I'd say that the markets have a rather good understanding of how we're likely to respond at this stage."

The markets are discounting a 99% chance of a +25 bp ECB rate hike at its next policy meeting on September 10.

USD/JPY (^USDJPY) is down by -0.89% today.  The yen recovered from a 1-month low against the dollar today and rallied to a 1.5-week high after hawkish comments from BOJ Board Member Hajime Takata sparked short covering in the yen when he said the BOJ could raise rates more than expected this month or have back-to-back interest rate hikes.  The decline in T-note yields today also supports the yen.  In addition, lower crude oil prices today are positive for the Japanese economy and the yen, as Japan imports more than 90% of its energy. 

BOJ Board Member Hajime Takata said a 25 bp rate hike by the BOJ later this month "is not necessarily set in stone" and that back-to-back rate hikes would be a possibility.

The yen also 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%.

The yen has underlying support from increased expectations of 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. The markets are discounting a 97% chance of a +25 bp BOJ rate hike at the September 18 policy meeting. 

December COMEX gold (GCZ26) is up +36.90 (+0.84%) today, and December COMEX silver (SIZ26) is up +0.486 (+0.74%).

Precious metals recovered from overnight losses and turned higher today on short covering after the dollar index fell from a 2.5-week high and moved lower.  Gains in precious metals accelerated today after crude oil prices fell from a 6-week high and moved lower, which eased inflation expectations, a dovish factor for monetary policy and a supportive factor for precious metals. 

Precious metals initially moved lower today, with gold falling to a 4-week low and silver falling to a 2-week low.  The early rally in the dollar index to a 2.5-week high is bearish for metals prices. Also, escalation of hostilities between the US and Iran pushed crude oil prices to a 6-week high today, which raises inflation expectations that could persuade the world’s central banks to raise interest rates, a negative factor for precious metals.  In addition, hawkish comments today from ECB Governing Council member Nagel weighed on precious metals when he signaled the ECB will raise interest rates at this month’s ECB meeting. 

Recent fund support for precious metals is bullish for prices, as long holdings in gold ETFs climbed to a 4.25-month high today.  Long holdings in silver ETFs also rose to a 5-month high last Tuesday.

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.