Global currency markets experienced significant volatility this week, driven by a double blow from U.S. economic data. First, cooling inflation indicators reduced market expectations for an urgent Federal Reserve rate hike in September. Then, Friday's July retail sales report showed a sharp unexpected decline, further strengthening signs of a U.S. economic slowdown. This directly dragged the U.S. dollar index from near the 100 mark, allowing the euro and British pound to surge to multi-month highs. Meanwhile, the yen's rebound from a joint U.S.-Japan intervention two weeks ago has been nearly halved, refocusing market attention on the 160 level and the Bank of Japan's next move. Overall, the dollar is swinging between data and policy expectations, non-U.S. currencies are showing divergence, and risk sentiment along with oil price fluctuations are adding extra disruptions.
Cooling Inflation and Weak Retail Sales Combine to Loosen Dollar Policy Expectations
This week, the biggest influence on the dollar's trajectory was the consecutive release of U.S. inflation and consumer data. The July consumer price index cooled for a second straight month, and the final demand producer price index unexpectedly held steady. These data points collectively point to a moderation in inflation. Consequently, market expectations for a near-term Fed rate hike have fallen significantly. Traders now see the probability of a September rate hike at around 31% to 35%, down from roughly 55% a week ago. Although the likelihood of a rate hike before December remains above 60%, the urgency for immediate action has clearly diminished. Voices within the Fed are also not unified. Cleveland Fed President Hamack continues to emphasize that while inflation has improved, it is still far from the target, supporting further rate hikes to solidify gains. Richmond Fed President Barkin believes that if inflation continues to cool, it will help stabilize expectations, thereby reducing the need for a rate hike. A MUFG Bank forex strategist noted that the Fed's core challenge is balancing inflation risks with a cooling labor market, especially after the weaker-than-expected July nonfarm payrolls report. The strategist believes maintaining a restrictive stance in September, rather than pivoting to a rate hike, is more likely.
Friday's retail sales data delivered a more direct blow to the dollar. July retail sales fell 0.6%, far below market expectations for modest growth, and June's data was confirmed as only a 0.2% increase. The weakening consumer signal is clear, prompting traders to reassess the Fed's policy outlook. The dollar index fell 0.33% on Friday to close at 99.65, remaining under pressure below the 100 mark and ending the week nearly flat. The euro rose 0.35% against the dollar to close at 1.1568, hitting a session high of 1.1585, its highest since June 17, and posted a weekly gain of 0.1%. The British pound also rose 0.36% against the dollar to close at 1.3533, with a session high of 1.3561, its highest since May 12, and gained 0.32% for the week. Beyond the data, the new Fed Chair's simplified communication strategy is also a potential variable. The move to drop forward guidance and focus more on current economic conditions is seen by some investors as increasing policy path uncertainty. A Fitch Ratings U.S. economic research director pointed out that without clear forward guidance, the September rate decision is likely to remain uncertain until the last minute. Whether the Fed ultimately holds or hikes, both hawks and doves can find supporting data.
Yen Intervention Gains Nearly Halved, Focus on 160 and BOJ Rate Hike
Regarding the yen, a joint U.S.-Japan intervention two weeks ago pushed it up about 5%, but this rally has not been sustained. The yen has now given back about half of those intervention-driven gains. The yen fell about 1% against the dollar this week, closing at 159.32, its largest weekly decline in three months. It also fell about 1% against the euro, its largest weekly drop since April. Traders generally view the 160 level as a key threshold that could trigger a new round of official intervention. Market bets suggest authorities may need to act again to effectively curb the depreciation. A former Japanese Ministry of Finance currency official indicated that Japan is "ready" for joint intervention and hinted at faster-than-expected rate hikes to stabilize the currency. The U.S. Treasury Secretary, following the joint intervention, urged Japan to take "policy and fundamental" measures, which is interpreted as a signal for the Japanese government to moderate its dovish stance and allow the BOJ to hike rates. An OCBC strategist pointed out that the yen's pullback is not surprising, as intervention alone is difficult to change trends. The market needs to see the BOJ adopt a clearer hawkish stance. Market expectations for a BOJ rate hike in September have now risen to 76%, up significantly from 24% at the end of July. Analysts note that the BOJ could hike rates as early as September and consider a more aggressive path thereafter. Since ending its massive stimulus in 2024, the BOJ has roughly maintained a pace of two rate hikes per year, having raised rates to 1% in June this year. A BofA analyst team cautioned that the recent intervention failed to reverse the bearish sentiment towards the yen, which is now at its highest level in four years. Most fund managers believe a terminal rate of 2% is needed to stabilize the yen, meaning the BOJ needs to hike rates several more times. If the September meeting fails to meet market expectations, the yen could face further downward pressure.
Aussie Dollar Supported by Hawkish Central Bank, Sterling's Rally Gains Momentum
The Australian dollar extended its rally this week, closing near $0.7083, posting a weekly gain of about 0.27% for its third consecutive week of gains. It hit a fresh 10-week high of $0.7083 on Friday. The Reserve Bank of Australia held rates steady at 4.35% on Tuesday, but Governor Bullock delivered a more hawkish signal in a press conference, stating that if inflation does not fall as expected, another rate hike is "entirely possible." Assistant Governor Kent further noted on Thursday that inflation risks are clearly tilted to the upside, and if these risks materialize, rates will have to continue rising. The market now sees about a 70% probability of one more rate hike by early next year, taking rates to 4.60%, with November viewed as a potential first window. The chief economist at National Australia Bank, however, expects the monetary policy committee to keep rates unchanged and begin a gradual policy normalization process from mid-next year. The New Zealand dollar rebounded 0.67% on Friday, boosted by rate hike expectations, but still fell about 0.04% for the week. The British pound rose 0.32% this week, marking its third consecutive weekly gain. The UK's monthly economic growth unexpectedly accelerated to 0.3% in June, strengthening market confidence in the domestic economy. The Bank of England's chief economist stated that stronger-than-expected economic growth provides a rationale for a rate hike. The market currently maintains expectations for a single rate hike by the BOE this year, but a series of inflation data releases next week could introduce new variables. An CIBC strategist noted that while the growth is modest, it is driven by consumer spending and business investment rather than government spending, suggesting the UK economy may be more robust than initially thought.
Rising oil prices and escalating tensions in the Middle East provided additional background for the currency market this week. The conflict between the U.S. and Israel over Iran-related actions, along with efforts to restore navigation through the Strait of Hormuz, pushed international oil prices higher on Friday. This continues to provide some support for the dollar while also increasing volatility in risk-aversion sentiment.
Data and Policy Battles Will Continue to Dominate the Outlook
Overall, this week's currency market clearly reflected the two-way pull of U.S. economic data on the dollar. Cooling inflation reduced the urgency for a rate hike, while weak retail sales reinforced concerns about an economic slowdown. This ultimately pushed the dollar index below the 100 mark, with non-U.S. currencies, particularly the euro and pound, gaining support. The yen continues to seek balance between fading intervention effects and central bank policy expectations, with the 160 level becoming a highly watched psychological and technical threshold. The Australian dollar and British pound are performing relatively strongly, benefiting from their respective central banks' hawkish stances and improved economic data. Looking ahead to next week, the market will continue to digest the July personal consumption expenditures price index and related August data. It will also closely monitor statements from BOJ and Fed officials, with a particular focus on the Fed's meeting minutes. Against a backdrop of potential adjustments to the Fed's communication model and ongoing geopolitical disruptions, currency market volatility is likely to remain elevated. Whether it is the pricing of dollar policy or the yen's intervention and rate hike dynamics, more data and official signals are needed to confirm the direction.
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