The US dollar remained under pressure on Monday despite growing expectations that the Federal Reserve could raise interest rates this month, as heightened tensions in the Middle East fuelled concerns about renewed inflationary pressures and potentially prompted major central banks to tighten monetary policy simultaneously. The dollar’s weakness also reflected changing sentiment towards the Japanese yen, alongside persistent concerns over rising US government debt and uncertainty surrounding economic policy.
Currency movements were relatively subdued in early Asian trading, with US markets closed for a public holiday. The greenback struggled to maintain the gains recorded after Friday’s stronger than expected US employment figures. The euro edged up to $1.1618, while the pound was largely unchanged at $1.3519. Against a basket of major currencies, the dollar fell 0.07 percent to 99.09, remaining close to its recent low of 98.558.
Markets have significantly increased their expectations of a Federal Reserve rate increase this month following the latest nonfarm payrolls figures. Traders were pricing in about a 57 percent probability of a hike, with Friday’s US inflation figures expected to play a decisive role in determining the Fed’s next move.
“A hot CPI print would all but seal a September hike and underpin a firmer US dollar,” Elias Haddad, global head of markets strategy at BBH, said.
“A cooler reading would strengthen the case for a hold and leave the US dollar vulnerable to a dovish Fed repricing.”
Haddad nevertheless cautioned that even if the Fed raises rates in September, the dollar may struggle to return to recent cyclical highs because other major central banks are also expected to tighten policy. The prospect of prolonged inflation driven by elevated oil prices is already shaping expectations for monetary policy in Europe. Markets were pricing in a near certainty that the European Central Bank would raise rates to 2.75 percent on Thursday, while futures indicated a 75% probability of a further increase to 3 percent by December. Japan is also moving towards tighter monetary policy.
Markets were assigning a 75% probability that the Bank of Japan would raise its benchmark rate by a quarter percentage point at its 18 September meeting, with a further increase by December carrying a 60 percent probability.
The yen strengthened by more than 0.2% to 155.88 against the dollar on Monday, extending a rally that gained momentum after Japanese Prime Minister Sanae Takaichi’s economic adviser backed the prospect of a Bank of Japan rate increase this month. The Japanese currency rose more than 2% last week amid several factors, including the unwinding of carry trades and expectations that Japanese capital could be repatriated, increasing demand for the yen.
Eric Robertsen, global head of research and chief strategist at Standard Chartered, said the yen’s recent strength could challenge the performance of carry trades, which have remained among the strongest macroeconomic strategies this year despite rising borrowing costs globally.
“If the JPY were to strengthen persistently, this may signal that the increase in JPY and USD rates is starting to trigger a change in asset allocation,” Robertsen said.
Elsewhere, the Australian dollar rose 0.12% to $0.7208, while the New Zealand dollar was broadly unchanged at $0.5880.
Bitcoin, meanwhile, held above $80,000 and was last trading at $80,145.95. The cryptocurrency has recently benefited from investors seeking alternatives to dollar denominated assets amid uncertainty surrounding the US currency.
The competing forces now facing global currency markets leave investors focused on inflation data, central bank decisions and developments in energy markets. While stronger US economic data has revived expectations of tighter Federal Reserve policy, simultaneous tightening by other major central banks could limit any sustained recovery in the dollar.
