Global capital markets are repricing at the fastest clip in months after a run of soft US economic data extinguished expectations for a September rate hike from the Federal Reserve.
On August 17, the Bloomberg Dollar Spot Index dropped for a third straight session, touching its lowest level since May 15. Meanwhile, the MSCI Emerging Market Currency Index climbed as much as 0.2% intraday to 1906.98, marking an all-time high. The emerging market equity gauge advanced 0.6% in tandem, signaling a marked improvement in risk appetite.
Data trifecta: September hike odds slide from 75% to 30%
The dollar's sustained weakness is no accident. Within just two weeks, three sets of key economic data punctured market confidence in further Fed tightening.
The first blow came from July nonfarm payrolls, which unexpectedly contracted. Data released August 7 showed US employment fell by 23,000 jobs, versus market expectations for an increase of 80,000. May and June figures were revised sharply lower, with a combined downward revision of 103,000, offering clear evidence of cooling in the US labor market.
The second hit arrived as CPI and PPI both softened in July. Inflation readings returned to a downward trajectory, further eroding the urgency for additional Fed rate increases.
The third shock came from retail sales, which snapped a nine-month winning streak. US July retail sales dropped 0.6% month-over-month on August 14, far below the 0.1% gain anticipated by analysts. The control group, which feeds directly into GDP calculations, also posted a 0.4% decline. Consumer confidence deteriorated alongside, weighed down by rising living costs.
The cumulative effect of these three data points was immediate. According to the CME FedWatch tool, the implied probability of a September rate hike has plunged from roughly 75% in late July to just 30%. US swap markets now fully price in only a 25-basis-point hike by January of next year, a stark contrast to just a week ago when markets anticipated action before year-end. The remaining expected tightening across the entire cycle has narrowed to approximately 36 basis points.
Dollar stumbles, emerging markets celebrate
The direct consequence of a weaker dollar is a broad-based rally in emerging market assets. Wee Khoon Chong, senior Asia Pacific market strategist at BNY Mellon, noted that emerging market currencies are finding support today from both dollar softness and a sustained uptick in equity market risk appetite. He observed a strong resurgence of foreign fund inflows into emerging markets, particularly across Asia.
The carry trade is making a comeback. With the Fed's rate path flattening, the relatively higher yield advantage in emerging markets is once again attracting global capital in search of returns.
Geopolitical risk premiums are also retreating. Galvin Chia, emerging Asia strategist at Societe Generale, attributed the strength in Asian currencies to a confluence of factors, including last week's weak US data and early-week dollar declines. He added that the absence of fresh geopolitical headlines over the weekend, combined with Brent crude trading below $90, likely provided additional support to the region's currencies.
The DXY dollar index has fallen to around 99.50, hovering near two-month lows. EUR/USD has broken above the key 1.1577 resistance level and reclaimed its 100-day moving average. USD/JPY has retreated to approximately 159.
From a quantitative perspective, the 20-day correlation between the Citi US Economic Surprise Index and the dollar index stands at a striking 0.85, underscoring that unexpected shifts in economic data have become the core driver of dollar movements. Options market signals are equally clear: one-month options have flipped to bearish dollar positioning for the first time since late February, while longer-dated contracts continue to favor dollar strength.
Key catalysts this week: Can FOMC minutes ride to the hawkish rescue?
Whether the dollar's decline extends further hinges on two major events this week. On Wednesday, August 20, the minutes from the July FOMC meeting will be released. At the July 29 meeting, the Fed held rates steady at 3.5%-3.75% for a fifth consecutive session, but three dissenting votes emerged, with Dallas Fed President Lorie Logan, Cleveland Fed President Beth Hammack, and Minneapolis Fed President Neel Kashkari all advocating for a hike.
Chris Turner, global markets head at ING, suggested that if the minutes contain language indicating the decision to hold was closer than most anticipate, markets will find it difficult to swing fully back to a hawkish stance. As BNY Mellon's Chong pointed out, foreign capital is rebounding strongly into emerging markets. Societe Generale's Chia cautioned, however, that the tail end of the thin summer trading season, coupled with a vacuum of geopolitical news, may be amplifying current volatility.
The FOMC minutes will serve as the critical test for whether this trend can persist. Should they reveal a reaction function under the Fed's new leadership, market expectations for rate hike probabilities could shift. On Friday, PMI data will take center stage. If US PMI shows a widening growth advantage, it could provide some support for the dollar. Elias Haddad, global markets strategy head at Brown Brothers Harriman, noted that strong US economic data reinforcing America's growth edge could bolster the greenback.
The emerging market currency index at record highs, the dollar at three-month lows, and foreign funds flooding back into Asian markets - beneath these moves lies what appears to be a waning conviction in American exceptionalism.
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