ING: The USD - FJElite
Oil prices and global bond yields both surged yesterday. In G10 FX, the reaction looked more like a rates story than an oil story, propagating through the global risk sentiment channel. The high-beta Australian dollar, New Zealand dollar and Norwegian krone led losses on a strong day for the US dollar, while the more defensive sterling and Swiss franc proved relatively resilient.
The dollar is tentatively re-establishing a positive correlation with long-end yields, helped by a smaller-than-expected $6bn Treasury buyback announcement, which ultimately translated into an even smaller $5.19bn operation yesterday. US Treasury Secretary Scott Bessent's reluctance to pick a fight with the bond market through oversized intervention remains a necessary condition for that positive USD-back-end rates correlation to regain its footing.
Pricing for next week's FOMC inched up to 18bp yesterday, buoyed by the oil rally and a modest upward revision to July PPI, while August figures came in exactly on consensus. Today's August CPI release can provide the green light to fully price a September hike with even a marginal upside surprise. Consensus stands at 0.2% month-on-month for core and 0.4% for headline. That is also ING's macro team's expectation, and our assessment is that the acceleration in headline inflation would be enough to tilt the balance towards a hike despite still-benign core dynamics.
The picture becomes more nuanced in the event of a downside surprise. Federal Reserve Chair Kevin Warsh set a high bar for incoming data to overturn the hawkish narrative, but Christopher Waller later suggested no hike would be needed if inflation continued to improve through August. Oil may prove the deciding factor, having rallied around 15% since then. A softer CPI print could weigh on the dollar, but may not be enough to push September hike pricing below 50%, a level we suspect would be sufficient to bring any unconvinced FOMC members on board.
We continue to see upside potential for the dollar. The yen rally has stalled and is no longer exerting a negative spillover effect on USD. Developments in the Gulf leave the balance of risks skewed towards higher oil prices, while stress in bond markets is increasingly bleeding into risk assets. That combination should favour a defensive rotation back into the dollar. DXY 100.0 is starting to look less like a stretch target and more like a destination.