Investors shift their focus from jobs to CPI

The week that was

Joy can’t last forever, can it? 

The US Dollar (USD) rapidly faded its prior gains and resumed its marked downside this week, with the US Dollar Index (DXY) coming close to its psychological 100.00 barrier, only to see that dream turn to ashes as market chatter reignited speculation that the Bank of Japan (BoJ) might hike its policy rate at its next meeting.

But nobody, or nearly no one, said anything about a potential FX intervention by the MoF-BoJ duo.

Not even fresh tensions in the back-and-forth scenario in the Middle East were able to give the buck any fresh legs.

And then came Christopher Waller and John Williams, begging markets for patience while favouring the statu quo being left unchanged for now. Well, at the Federal Reserve’s (Fed) next meeting. 

Furthermore, the severe correction in the US Dollar has practically ignored the weekly developments from the US bond market, where US Treasury yields remained in the upper end of their recent range despite their mixed performance.

It is not the labour market, stupid! 

The sharp rebound of the US Dollar Index soon after Nonfarm Payrolls (+162K) was just that: a robust, albeit temporary, bounce.

It was clearly indicative of how surprised market participants were after the final print crushed prior estimates last month.

But again, as the week was drawing to a close, the index had already returned to pre-release levels and was maybe entering the usual pre-CPI lull, which should be exacerbated by the shortened trading week in light of the Labor Day holiday on Monday.

The labour market does not matter; it does not count in the Fed’s equation today. The jobs market remains broadly healthy and, what’s more important, stable. Boring.

We don’t need more evidence than the already exposed comments from Chair Kevin Warsh and most of the FOMC, which highlight the importance of bringing inflation toward the Fed’s goal, attempting to keep inflation under control, or at least pretending to.

Hawks playing hide and seek

Fed rate setters delivered a mixed but increasingly alert message on the policy outlook. Indeed, Michael Barr (Board of Governors) warned that rates may need to rise if inflation fails to moderate, while John Williams (New York) pointed to encouraging disinflation and supported the July decision to wait; Christopher Waller (Board of Governors) focused on the structural forces lifting bond yields and the importance of a clear Fed reaction function.

Barr offered the clearest warning on rates, saying inflation remained too high and that persistent price pressures created risks. He favours keeping rates steady if inflation is clearly moderating, but he argued that a rate increase would be appropriate if progress does not arrive soon. Stable employment, low unemployment and solid growth, partly supported by AI investment, mean the Fed cannot rely on a weakening economy to bring prices down.

Contrasting a bit, Williams said that recent inflation data had been encouraging, inflation expectations remained contained and there was a trend towards lower price growth. He also described the labour market as stable and solid, supported the July FOMC outcome and said officials needed to gather more data before the next meeting. In his view, rising Treasury yields reflected a strong economy, robust investment demand and tighter financial conditions rather than a deterioration in the inflation outlook.

Waller, instead, concentrated on why yields are rising and how the Fed should respond. He cited a higher term premium, uncertainty over the global outlook and the possible erosion of the US Dollar’s reserve-currency “convenience yield”. He urged policymakers to focus on the economy and the Fed’s dual mandate rather than attempting to react to every market move, while arguing that investors need a consistent and predictable reaction function.

The overall tone was mixed, with a hawkish undertone. Barr’s conditional call for a rate hike strengthens the case for renewed tightening if inflation remains sticky, while Williams’ more reassuring assessment supports patience. Waller did not give a clear rate signal, but his stress on the Fed focusing on its mandate rather than on market conditions reinforces the message that future policy will be data-driven, not bond-market-driven.

Meanwhile, markets see nearly 35 basis points of tightening by year-end, while a 25-basis-point rate increase is the favoured scenario for the September 16 meeting.

Net longs hold steady as conviction weakens

USD bullish positioning was broadly stable in the week ending August 25, according to the Commodity Futures Trading Commission (CFTC). Indeed, net speculative longs slipped by just 397 contracts to nearly 18.7K contracts, following the larger declines seen in the previous two weeks. As a result, the 4-week change eased to +1,485 (from +3,465), showing that the recent bullish momentum has nearly stalled.

In addition, open interest was virtually unchanged at almost 48K contracts, up marginally from the previous week. Therefore, with positioning and participation both broadly flat, the latest move appears to reflect consolidation and marginal long liquidation rather than a decisive build-up of fresh USD shorts.

Extra data saw speculative exposure edging lower to 38.96% (from 39.81%), while its percentile remained at 57. The net-position percentile also eased to 67.4 (from 68.5). Both measures remain above neutral levels, indicating that the Greenback still retains a historically constructive positioning backdrop, although the degree of conviction has diminished.

Overall, USD positioning remains net long but is losing momentum. There is no major increase in open interest which could have been a sign of aggressive bearishness by speculators; rather, it appears that they are gradually cutting down on their bullish exposure. So, a sustained move below current levels would be required to confirm a broader move out of the dollar.

Next on tap for the buck

Next week won’t be busy in terms of data releases, but it promises to be entertaining enough overall, especially in the latter part of the week with the publication of crucial inflation data measured by the Consumer Price Index (CPI) for August. In tandem with the CPI will be the usual weekly Initial Jobless Claims, Producer Prices and the flash U-Mich Consumer Sentiment for the current month.

Radio silence on the Fed front, as it has entered its blackout period.

Inflation remains the US Dollar’s key ally

The easy part of the inflation story now seems to be behind us. Price pressures have eased significantly from their post-pandemic peaks, but reducing inflation from around 3% to the Fed’s 2% target is proving much more difficult than bringing it down from 9%.

That could keep the US Dollar well supported in the months ahead. As long as underlying inflation remains sticky, the Fed is likely to remain cautious about cutting interest rates, helping preserve the Greenback’s yield advantage over many of its peers.

Add lingering concerns over the US fiscal outlook and an uncertain global backdrop, and it is easy to see why investors may be reluctant to abandon the USD just yet.