The US Dollar opened the new trading week with a spring in its step, only to give back much of that early advance on Monday. The US Dollar Index (DXY), which measures the greenback against a basket of six major currencies, slipped from an intraday peak of 101.14 to trade around 100.92. Behind the retreat is a simple caution: traders want a clearer read on where the Federal Reserve is heading with interest rates before committing to any fresh directional bets.
That caution is being fed by a mixed set of signals from the American economy. Weaker-than-expected US jobs data and cooling Oil prices have together chipped away at the earlier worry that the Fed might tighten again in the near term.
Why cheaper Oil matters for rates
The softer Oil prices have eased the risk of fresh inflation. The read-across is straightforward: the Fed may not need to squeeze monetary policy as aggressively as markets had feared only a short while ago. In other words, some of the pressure to keep hiking has quietly come off.
Even so, the picture is far from settled. Inflation is still running above the Fed's 2% target, and policymakers remain committed to dragging it back to that level. The implication is that monetary policy is likely to stay restrictive for now, and anyone betting on quick relief may be getting ahead of themselves.
What the rate-bet math looks like now
The mood among traders shows up clearly in the CME FedWatch Tool. It puts a 77% probability on the Fed leaving interest rates unchanged at this month's meeting. Meanwhile, the odds of a hike at the September meeting have slipped to 56%, down from 63% before the US jobs report landed. Put simply, the soft data has thinned out the crowd betting on higher rates.
The Iran standoff overhanging markets
On the geopolitical side, the United States and Iran have still not sealed a final agreement, and that open question is weighing on sentiment. The key sticking points include how the Strait of Hormuz will be managed going forward, the release of frozen Iranian assets, relief from sanctions, and the commitments Tehran is willing to make over its nuclear program. Until there is common ground on these, the tension is set to linger.
A closer look at the services data
On the data front, the ISM Services Purchasing Managers Index (PMI) printed 54.0 in June, matching market expectations. While that was a touch below May's 54.5, it still marked the 23rd consecutive month of expansion. In other words, activity in the services sector keeps growing, a reassuring signal for the broader economy.
How the Fed actually steers the Dollar
Monetary policy in the US is shaped by the Federal Reserve (Fed), which works toward two goals: price stability and full employment. Its main lever for both is adjusting interest rates.
When prices climb too fast and inflation runs above the Fed's 2% target, the Fed raises interest rates, pushing up borrowing costs across the economy. The result is usually a stronger US Dollar, because higher rates make the US a more attractive place for international investors to park their money. Flip the situation, and it works the other way: when inflation falls below 2% or the Unemployment Rate climbs too high, the Fed may cut rates to encourage borrowing, and that tends to weigh on the greenback.
Inside the FOMC
The Fed holds eight policy meetings a year, at which the Federal Open Market Committee (FOMC) sizes up economic conditions and takes its monetary policy decisions. Twelve Fed officials sit on the FOMC: the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who rotate through one-year terms.
QE and QT, explained
In extreme situations, the Fed can turn to a policy called Quantitative Easing (QE). This is the process through which the Fed dramatically boosts the flow of credit into a jammed-up financial system. It is a non-standard measure reserved for crises or moments when inflation is unusually low. It was the Fed's weapon of choice during the Great Financial Crisis of 2008. In practice, the Fed prints more Dollars and uses them to buy high-grade bonds from financial institutions, and QE usually weakens the US Dollar.
Quantitative Tightening (QT) is the mirror image. Here the Fed stops buying bonds from financial institutions and does not reinvest the principal from its maturing holdings into new bonds. This process is generally positive for the value of the US Dollar.
How the other currencies and assets moved
The British Pound ticked lower against the US Dollar on Monday as it tried to close out a seven-day rally, with fresh tension flaring in the Strait of Hormuz, one of the critical points in the peace process between Washington and Tehran. GBP/USD traded near 1.3340, down from last week's 1.3387 highs, though its near-term bullish trend stayed intact.
EUR/USD also came under pressure on Monday, though it managed to trim its earlier losses and climb back to the 1.1430 zone, leaving it marginally lower on the day. The mild pullback came on the back of modest gains in the US Dollar during what was a fairly listless start to the week.
Gold slid under renewed selling pressure on Monday, reversing three straight daily upticks and running into early resistance around the $4,200 mark per troy ounce. With tensions around the Strait of Hormuz souring sentiment, safe-haven demand shifted toward the US Dollar instead, capping the metal's upside.
The cryptocurrency market was broadly weak on Monday too, with Bitcoin (BTC) sliding under the $63,000 level amid the wider risk aversion.
As the king of safe havens, the Swiss Franc was supposed to draw support from a geopolitical shock like the Iran war. This time, it did not. Following a sharp decline that accompanied the war in Iran and the closure of the Strait of Hormuz, the Swissie now sits nearly 6% below its January peak against the USD.
All eyes on Sintra
Financial markets arrived in Sintra hunting for clues about the Fed's next move. What most of them left with was confirmation of something else: that Fed Chair Kevin Warsh intends to make those clues far harder to find. Rather than lifting the fog, the gathering seems to have thickened it.
