US Dollar: Fed expectations weigh on Dollar – Commerzbank

Commerzbank’s Volkmar Baur notes that softer US inflation has reduced expectations for Federal Reserve rate hikes and pressured the US Dollar. June headline and core inflation fell more than consensus, leading markets to price out roughly half a hike by year-end. Baur argues that improving productivity and AI-related investment support a wait-and-see Fed stance, keeping the Dollar under pressure, though higher Oil prices may slow adjustment.

Lower inflation shifts Fed pricing

"The lower inflation figures also had an impact on the fx market. On a trade-weighted basis, the US dollar lost about 0.3% yesterday, and it also gave up a similar amount against the euro. While the market had previously anticipated about 1.7 interest rate hikes by year-end, by the end of the day that figure had dropped to just 1.2."

"Although Waller’s speech the previous day was interpreted as hawkish in some news reports, Waller stated explicitly that while inflation was too high in his view, the situation was clearly different from that in 2022 (when interest rates were raised). He noted that the labor market is currently nowhere near as tight as it was back then, and that inflation expectations remain low."

"He also said that a wage increase of currently around 3.5% is consistent with inflation of around 2%, because productivity is improving accordingly. And this is likely to be the main argument for a wait-and-see monetary policy in the coming months."

"In this regard, it’s still reasonable to assume that the market will have to continue adjusting its expectations of the Fed, which will weigh on the US dollar. However, given the renewed flare-up of the Iran conflict and the resulting rise in oil prices, this is likely to take some time yet."