Dollar Slips as T-note Yields Stabilize and Stocks Rally

The dollar index (DXY00) fell from a 2.5-week high on Wednesday and finished down by -0.08%.  The dollar gave up an overnight advance and turned lower today when the weaker-than-expected US Aug ADP employment report knocked T-note yields lower.  The dollar also came under pressure on dovish comments from New York Fed President John Williams, who said inflation is continuing to trend down.  In addition, strength in stocks on Wednesday reduced liquidity demand for the dollar.

The dollar initially moved higher on Wednesday 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. 

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.

The Fed Beige Book was mildly dollar-supportive, stating that economic activity in the Fed's 12 districts in the period through August 24 "increased modestly," with prices accelerating moderately in most districts.  Also, “healthy labor demand was seen most frequently in manufacturing, construction and some service sectors, while retail and hospitality sectors saw falling labor demand."

New York Fed President John Williams said, "The data recently has been encouraging.  I am actually seeing the trend in inflation moving slowly down as some of the effects of the tariffs move into the rearview mirror."

WTI crude prices rose to a 6-week high on Wednesday, initially 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 65% 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 on Wednesday and finished down by -0.08%.  The euro was pressured by Wednesday’s rally in crude oil prices to a 6-week high, which is bearish for the Eurozone economy and the euro, as Europe imports most of its energy. 

However, euro losses were limited by 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% on Wednesday, 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) fell by -0.76% on Wednesday.  The yen recovered from a 1-month low against the dollar on Wednesday 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 on Wednesday also supports the yen.  The yen fell back from its best level on Wednesday after crude oil prices rallied to a 6-week high, which is bearish for Japan’s 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 later this month.  The markets are discounting a 100% chance of a +25 bp BOJ rate hike at the September 18 policy meeting.  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. 

December COMEX gold (GCZ26) closed up +18.20 (+0.41%) on Wednesday, and December COMEX silver (SIZ26) closed up +0.094 (+0.14%).

Precious metals recovered from overnight losses and settled higher on Wednesday as short covering emerged after the dollar index fell from a 2.5-week high and moved lower.  Also, dovish comments from New York Fed President John Williams boosted precious metals prices when he said inflation is continuing to trend down. 

Precious metals initially moved lower on Wednesday, 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 was bearish for metals prices. Also, escalation of hostilities between the US and Iran pushed crude oil prices to a 6-week high on Wednesday, 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 on Wednesday.  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.

On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.