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US dollar softens ahead of inflation report

THE United States (U.S.) dollar index fell below 101.6 on Wednesday, hitting its weakest levels in two months amid growing expectations that US inflation will continue to ease and that the Federal Reserve will soon stop hiking rates.

Earlier in the week, several US central bank officials said they will likely lift rates further this year to bring down inflation that is still too high, but the end of the current monetary policy tightening cycle is getting closer.

Meanwhile, the latest data showed that US consumer inflation expectations for the year ahead fell for a third consecutive month to 3.8% in June 2023 from 4.1% in May, the lowest in over two years.

Economic optimism in the US also unexpectedly declined to an eight-month low in July. Investors now look ahead to the June US consumer price index report to provide clarity on the Fed’s progress in fighting inflation.

The dollar weakened the most against the Australian and New Zealand dollars, while it depreciated to an almost one-month low against the Japanese yen. The dollar has started the week on the soft side, ING Chris Turner said in a note.

There has not been too much data but the push factor of the Fed/US interest rate story versus the pull factor of overseas asset markets is slightly working against the dollar.

On the former, US short-dated rates came off 10bp in the European afternoon yesterday seemingly on the back of a New York Fed consumer inflation expectations survey that in the one-year tenor fell to the lowest levels since April 2021.

The market seemed to ignore three Fed speakers all sticking to the script that the policy rate would probably need to be hiked another 25bp or 50bp this year.

Turner said in terms of the pull factor, some very modest support measures announced for the Chinese property sector seem to be raising speculation that broader support for the private sector will be forthcoming this summer. Asian equities are modestly bid today.

“.. a story that caught our eye in today’s Financial Times may be partially explaining this soft dollar tone. The report suggests hedge funds have slashed their positions in US equities to the lowest in a decade and are turning their attention to under-valued European equities.

“Obviously, there are myriad factors that drive FX rates, but one can argue that the dollar trading to the weak side of what interest rate differentials suggest may be partially down to this kind of rotation.

“Remember that unlike bond market flows, equity flows are normally left FX unhedged. We do not expect big FX moves today, but DXY could continue drifting toward the 101.50 area”, Chris stated.

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