US dollar stays near multi-month lows with Fed rate outlook back in focus

Dubai: The US dollar hovered near multi-month lows against major currencies on Wednesday, with softer Treasury yields and reduced expectations for another near-term Federal Reserve rate increase weighing on the currency ahead of the release of the central bank's latest meeting minutes.

The dollar index, which tracks the US currency against six major peers, slipped marginally to 99.65. The euro edged up to $1.1577, remaining close to the two-month high reached earlier this week, while sterling held at $1.3533 near a three-month high ahead of British inflation data.

Stephen Innes, financial market strategist and commentator, said the latest dollar weakness was still being driven by softer US economic readings and changing expectations around Federal Reserve policy.

Investors are now waiting for the minutes of the Federal Reserve's July meeting for further clues on the direction of interest rates, with the release drawing added attention following the recent move in US bond markets.

Jonathan Squires, CEO of Tapaas, said markets are assigning a 67% probability to the Federal Reserve holding interest rates at its September meeting, while expectations of a hike have declined over the past week following softer labour market and inflation data.

The possibility of another rate increase later in the year has not disappeared, however, which is helping to limit further dollar weakness, according to Squires.

Longer-dated US Treasury yields also remain close to multi-year highs amid debt issuance, fiscal spending and inflation concerns linked to elevated oil prices.

Innes said the distinction between movements at the short and long ends of the bond market has become increasingly important for currencies.

“A bond market selloff driven by expectations of tighter Fed policy is normally straightforwardly dollar positive. A selloff driven by rising term premium, policy uncertainty and concern over the long run fiscal backdrop is a much more complicated animal.”

The euro remained close to its strongest level in two months, although Innes cautioned against assuming that Europe offered a straightforward alternative to the US currency.

Natural gas prices are moving toward their highs for the year while inflation remains persistent enough to maintain pressure on the European Central Bank, according to his analysis.

“That combination may offer EUR/USD some support, but it also argues against chasing the pair too aggressively above 1.1625.”

Sterling was little changed at $1.3533, keeping it close to a three-month high before the release of UK inflation data later on Wednesday.

The Japanese yen was also broadly steady at 159.56 per dollar. The currency has surrendered much of the gain recorded around earlier intervention moves, although it remains stronger than the multi-decade low of around 164 per dollar.

The Australian dollar and New Zealand dollar showed little movement, trading at $0.7083 and $0.5874 respectively.

Attention is also turning to whether elevated long-term borrowing costs begin to have a broader impact beyond bond markets.

Innes said higher long-term yields can feed into mortgage rates, housing activity and refinancing costs, tightening financial conditions across the wider economy.

Squires said geopolitical developments in the Middle East could remain another influence on the dollar, with reduced US military action potentially limiting safe-haven demand while renewed escalation could support both the currency and Treasury yields.

Markets will now look to the Fed minutes, upcoming US economic releases and the central bank's Jackson Hole event later this month for further direction.

Innes said the immediate direction of the dollar remains closely tied to expectations at the shorter end of the US interest-rate curve, while developments in longer-term yields could determine whether the current pressure spreads more widely.

“The front end may decide the dollar’s direction today. The long end may decide whether this becomes something much bigger.”

- With inputs from WAM and Reuters.