FX Daily: Dollar drifts higher ahead of Jackson Hole speech

The dollar is doing a little better as investors re-adjust their pricing for the 17 September FOMC meeting. 10 days ago, the market priced a 27bp rate cut. Today, just an 18bp cut is priced in. This adjustment has provided a little support to the dollar. Driving that most recent change in expectations was yesterday's release of US S&P PMI data for August. Confidence rose both in the manufacturing and service sectors, pushing the composite PMI data to the highest levels since last December. On paper, then, the data doesn't really support the President's call for emergency rate cuts. The argument from the Federal Reserve doves, however, is that precautionary rate cuts are required to avoid a needless rise in unemployment.

That brings us to today's keynote speech from Fed Chair Jerome Powell at 16:00 CET today. Speaking to ING's US economist, James Knightley, earlier this week, James made the good point that Powell may want to stick to the script and keep the Fed's options open for September. The script can be considered the Fed's Summary of Economic Projections (SEP), which in June saw a median of Fed members expecting two rate cuts this year.

Powell can hang the Fed's September decision on the forthcoming August data releases of jobs (5 September) and CPI (11 September). His equivocal remarks might come as a disappointment to those looking for full-throated support for a rate cut in September. However, he is going to have to acknowledge the sharp downward revisions to the jobs data in May and June, and it seems unlikely the market will start to price the probability of a September rate cut at less than 50%.

DXY has been a little stronger than we were expecting this week, but we imagine sellers would return if DXY got anywhere near the 99.00/99.10 area, which we would see as a near-term top.

Elsewhere, we note the continued decline in the amount of US Treasuries held in custody by the Fed on behalf of foreign official institutions. The weekly data released last night showed holdings dropping to the lowest levels of the year and down $100bn from early April. The US Treasury market, however, is doing fine, and one could argue that structural factors like adjustments to the Enhanced Supplementary Liquidity Ratio or the need to back Stablecoins with Treasury Bills are helping.

Yet the Fed custody holdings data suggests that foreign central banks may be continuing to reduce US Treasuries and potentially dollar exposure, too, in their FX reserves. In other words, while the Treasury market may be ok in that the US private sector picks up the slack from foreign official sales, the impact on the dollar may still be negative.

Chris Turner

EUR/USD is edging lower, driven both by the dollar and fading prospects of any near-term improvement in Ukraine. On the eurozone calendar today is the negotiated wage number for the second quarter. At its peak last year, this was running at 5.4% year-on-year and was clearly worrying the European Central Bank about second-round effects from high inflation. This had dropped to 2.4% in the first quarter, and another softer number today would no doubt be welcomed by the ECB. That said, the market has completely priced out any easing from the central bank this year, and we will need to see some sharp deterioration in the hard data to put that back on the agenda.

Elsewhere, the EU and US put some more flesh on the bones of a trade deal yesterday. Europe would like to move on, but there still seems to be some uncertainty as to whether pharma and semiconductor tariffs will be capped at 15% or whether US Section 232 investigations could result in higher tariffs after all.

For today, Powell's tone will determine whether EUR/USD has to trade all the way back to the 1.1500/1520 area, which is the outside risk should he manage to swing market pricing back to 50:50 for a restart to the Fed easing cycle in September.

Chris Turner

As Min Joo Kang discusses in her review of the Japanese July CPI data, core inflation continuing to run at 3.4% YoY suggests the Bank of Japan will hike rates in October. A 25bp hike in October is currently priced with a 42% probability. The BoJ may also be interested in hiking rates in order to stabilise the long end of the JGB market, where 30-year yields overnight hit the highest levels in over a quarter of a century. (The steeper yield curve is good news for Japanese banks, however, where the Topix banks index is up 23% year-to-date).

Given that our call is that the Fed will restart its easing cycle in September after all, it looks like the current run-up in USD/JPY will not last. We see gains petering out in the 148.75/149.10 area and would expect USD/JPY to be back pressing 146.00 ahead of the Fed meeting in September.

Chris Turner

EUR/CHF is comfortably trading under 0.94 again as optimism over a Ukraine ceasefire fades. As with ECB pricing, expectations of a Swiss National Bank rate cut in September have faded, and investors now struggle to see the SNB taking rates negative at all.

In terms of our FX views, we see little change in our view published in early July that the strong CHF creates a big headache for the SNB – but there's little the central bank can do about it. We see no reason to change our view that EUR/CHF can continue to trade down at these 0.93 levels for a while longer.

Chris Turner