The US dollar index fell 0.48% this week, closing at 100.87, marking its largest weekly decline since early April and its worst weekly performance in 12 weeks. The core catalyst for this movement was the weak US June nonfarm payrolls report released on Thursday, which showed not only a significant miss in new job additions compared to market expectations but also downward revisions to the gains from the previous two months.
The cooling signals from the jobs market prompted traders to drastically scale back bets on near-term Federal Reserve interest rate hikes. According to real-time data from the CME FedWatch Tool, the market-implied probability of a Fed rate hike at the September meeting has dropped to around 45%.
Karl Steiner, Head of Analysis at SEB, explicitly stated that their forecast model does not include a scenario for further rate hikes. He noted that the employment data aligns with their view that "policy will ultimately shift and the dollar will weaken," and he expects the dollar could face more significant downside pressure. It's worth noting that the US Treasury market was closed on Friday for the Independence Day holiday, which amplified currency market volatility to some extent amid thin trading conditions.
Yen Rebound and Intervention Risk
The US dollar against the Japanese yen experienced volatile swings this week. It hit a 40-year high of 162.83 on Wednesday but then tumbled sharply from that level on Thursday, influenced by the US nonfarm data and amid extremely thin liquidity ahead of the US holiday and a market closure in Japan. The pair ultimately closed the week at 161.35. Although USD/JPY recovered some ground on Friday, market participants remain highly vigilant over possible past or imminent currency intervention by Japanese authorities.
Japanese Finance Minister Shunichi Suzuki reiterated at a regular press conference on Friday that Tokyo maintains regular contact with Washington on currency matters, even during the North American holiday, and emphasized that they "will take appropriate action as needed."
Chief Cabinet Secretary Yoshimasa Hayashi stated that they are monitoring market moves with a "high sense of urgency." IG analyst Tony Sycamore pointed out that whether the 162.83 level becomes a more meaningful medium-term top largely depends on upcoming US economic data and developments in the Japanese government bond market. SEB analyst Steiner added that, based on historical experience, Japanese authorities tend to prefer intervening in lower-liquidity market environments, making the current timing particularly noteworthy.
The Japanese government faces an increasingly severe policy dilemma between currency intervention and fiscal discipline. Economic blueprints from Prime Minister Sanae Takaichi, hinting at substantial new spending, triggered a sharp reaction in the bond market—the benchmark 10-year Japanese government bond yield surged to a 30-year high on Friday. Investors are concerned that large-scale fiscal expansion could conflict with the Bank of Japan's monetary tightening process and may even signal government resistance to further rate hikes.
Although Finance Minister Suzuki tried to quell market speculation, arguing that the economic blueprint merely reiterated the "government's consistent stance," signs of unease have emerged within the decision-making circle. Toshihiro Nagahama, a private-sector member of the Council on Economic and Fiscal Policy and considered an economic advisor to the dovish-leaning Prime Minister Takaichi, publicly stated that the BOJ should continue raising interest rates at a "moderate pace" to correct excessive yen weakness. Meanwhile, warnings issued on Friday suggested that Japanese officials might abandon the previous practice of signaling intervention risks in advance, opting instead for more targeted actions to pressure speculators and increase the cost of shorting the yen.
Against the backdrop of persistent yen weakness, the Japanese economy shows some resilience but also faces pressure from rising import costs. Final statistics from Japan's largest labor union, Rengo, show that after the 2026 annual wage negotiations, employees at 5,368 member firms secured an average pay raise of 5.01%. Although slightly lower than last year's 5.25%, this marks the third consecutive year the raise has met Rengo's 5% target—the first time since the bubble economy period from 1989 to 1991 that pay increases have exceeded 5% for three straight years. This data reinforces the Bank of Japan's stance for continued rate hikes.
Ryunosuke Kono, an economist at BNP Paribas, significantly raised his forecast for Japan's terminal interest rate from 2.00% to 2.50%. He expects the BOJ to maintain a gradual tightening pace of one rate hike every four to five months, with the policy rate potentially reaching 1.25% by the end of 2026, 2.00% by the end of 2027, and finally hitting the terminal ceiling of 2.50% in September 2028.
Euro Dynamics and the European Central Bank
The euro benefited from broad-based US dollar weakness this week. The euro against the US dollar closed the week up 0.45% at $1.1435, having earlier touched its highest level in nearly two weeks. The policy stance of the European Central Bank provided additional support for the euro. Derek Halpenny of MUFG noted in a report that the ECB may still lean towards further rate hikes due to persistent inflation risks. Although crude oil tanker traffic has recovered following the US-Iran ceasefire agreement and the reopening of the Strait of Hormuz, liquefied natural gas shipments have not rebounded in tandem, meaning energy-related inflation risks are not yet fully eliminated.
ECB President Christine Lagarde explicitly mentioned the possibility of "not ruling out an early departure to have a voice in the 2027 French presidential election" and emphasized that all data received since the last rate hike confirms the correctness of the bank's decision. The ECB raised its key interest rates last month, a move some economists deemed unnecessary as oil prices had fallen back to near pre-war levels. However, Lagarde's remarks indicate that policymakers remain highly vigilant on the inflation outlook, providing policy support for the euro's medium-term trajectory.
Sterling Dynamics and the Bank of England
The British pound against the US dollar rose about 1.2% this week, closing around $1.3348, marking its best weekly performance in nearly three months and its largest weekly gain in 12 weeks.
The pound's rise was driven by a dual factor: on one hand, weak US jobs data pressured the dollar; on the other, domestic political risks in the UK eased somewhat. Previously, news that Labour MP Andy Burnham had secured enough support to potentially launch a leadership challenge within the party had unsettled markets, especially his statement that Britain must "break free from dependence on the bond market," which raised investor concerns about possible abandonment of fiscal discipline.
However, Burnham's subsequent commitment to adhere to the current fiscal rules—including balancing day-to-day spending with tax revenues and gradually reducing the debt-to-GDP ratio—provided some comfort to the market.
SEB analyst Steiner noted that "some of the risk premium in sterling is fading away." Meanwhile, the Bank of England's policy outlook remains a market focus. Monetary Policy Committee member Catherine Mann stated that the easing of financial conditions since the June rate meeting would be a key factor influencing her vote at the July meeting.
Money market futures indicate a roughly 70% probability of a Bank of England rate hike by the end of the year. Before the outbreak of the Middle East conflict, investors had expected two rate cuts in 2026.
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