The dollar slips back despite Middle East escalation
The dollar softened despite renewed US-Iran strikes, higher oil prices and increased expectations of a September Fed rate rise, while markets await key US data including ISM, JOLTS and payrolls.
USD
The dollar traded marginally softer in quiet month-end conditions yesterday, an unusual outcome given a deteriorating geopolitical backdrop. The US and Iran resumed exchanging strikes after roughly a month of ceasefire, with weekend US strikes on Iranian rocket launchers on Larak Island met by Iranian retaliation against US bases. This mix saw Brent trading above $91 per barrel, while 10-year Treasury yields rose towards 4.75%. Combined with Chair Warsh’s Jackson Hole comments late on Friday, broadly interpreted as hawkish, markets now price roughly a two-thirds probability of a September rate rise. And yet, the greenback failed to capitalise, rounding off the month by partially erasing some of its Friday rally. We can sympathise. Granted, the odds of a September rate increase have clearly risen; we are not ready to make policy tightening later this month our baseline just yet (although we will be reviewing this call over coming days). That said, Warsh has likely boxed himself into a corner, and an unfavourably hot CPI print later this month would probably tip the balance. For now, though, we continue to think the Fed leaves policy unchanged this year, leaving risks skewed towards an unwind of hike pricing. Today's ISM manufacturing and JOLTS reports at 15:00 BST provide the next immediate tests, though as we flagged in our week ahead publication, Friday's payrolls report is the next big data point ahead of August CPI.
EUR
The euro was amongst the better performers yesterday, and EURUSD enters the European session in the low 1.16s, consistent with our view that the pair should hold recent ranges, with 1.17 the key topside level should dollar weakness extend. German inflation printed at 2.9% YoY in August, a third consecutive acceleration, but below consensus, following upside surprises in France and Spain last week. With the ECB having already lifted rates once and a further hike at next week's meeting largely priced, this morning's flash eurozone HICP release at 10:00 BST is the last major input, with consensus looking for headline inflation to rise to 3.3% from 2.9%, but with core seen unchanged at 2.5%. An in-line or firmer print should cement tightening expectations and support the single currency, though we would caution that an energy-led inflation impulse stemming from Middle East hostilities is a double-edged sword for the euro, given the bloc's vulnerability to an oil supply shock via the Strait of Hormuz. Euro area unemployment and final manufacturing PMIs are also due.
GBP
Sterling endured a quiet session yesterday with UK markets closed for the summer bank holiday, leaving cable consolidating around the mid-1.35s after Friday's Warsh-induced slide from the 1.36 handle. The reopening of the gilt market this morning is the immediate focus: 10-year yields sit above 5%, the highest in the G7, with sterling still trading with a fiscal risk premium - not helped by reports of government backsliding over the weekend ahead of the Autumn Budget. With only final manufacturing PMIs due today and the next MPC decision not until September 17th, we expect sterling to trade with the broad dollar tone and long-end gilt moves, with risks tilted modestly lower into the Budget.
CAD
The loonie was a notable outperformer yesterday, with USDCAD pressing down to the mid-1.38s as elevated oil prices flattered Canada's terms of trade, WTI closing near $87 after Hormuz tensions gapped crude higher at the weekly open. Even so, we are wary of chasing CAD strength. The collapse of US-Canada trade talks, and the resulting tit-for-tat tariff measures, poses an acute headwind for CAD. Tomorrow's Bank of Canada decision at 14:45 BST should see a unanimous hold at 2.25% for a seventh consecutive meeting, leaving the guidance to do the work as the Bank navigates 3% headline inflation against a looming tariff shock. With some domestic banks now calling for hikes as soon as October, a hawkish tone is a risk, though we still see scope for USDCAD to grind toward 1.39–1.40 should the BoC provide more balanced guidance, as we expect, especially if the Fed narrative stays hawkish and oil retraces.