Dollar Weakening Depends on Soft US Inflation Prints Ahead of Fed Meeting

Financial markets are currently caught between two major events: the ongoing conflict in the Gulf and the upcoming Federal Reserve meeting on September 16. A narrow path favors lower energy prices and unchanged Fed policy, leading to a benign weakening of the dollar. However, this outcome depends heavily on two soft US Consumer Price Index (CPI) prints ahead of the FOMC meeting. Failure to see these would likely point to a Fed hike and a stronger dollar.

ING Think believes that a European Central Bank hike in September will lead to a modest rise in EUR/USD to 1.18 by year-end, unchanged Fed policy creating fertile ground for intervention to bring USD/JPY lower. A Bank of Japan rate hike could be the quid pro quo for US participation in intervention, but Washington may also want to apply the brakes to the slide in North Asian currencies due to concerns about the renminbi regaining its recent gains.

Within G10, a pro-risk environment will continue to favor high-yielding currencies with commodity exposure, keeping the Australian dollar and Norwegian krone in demand. Sterling is a relative high-yielder but expectations of Bank of England tightening should start to fade this autumn. The UK Budget in October poses an event risk.

Assuming ING Think's Fed call is correct, emerging currencies will likely see another supportive period. Some of the highest yields are found in Latin America, with the October elections in Brazil posing a threat to the otherwise popular real.