Dollar Weakness Hinges on US Inflation Data Amid Global Central Bank Shifts

The FX markets are navigating a delicate situation, caught between developments in the Gulf region and the upcoming Federal Reserve meeting on September 16. The outcome of this balancing act will determine whether we see lower energy prices, unchanged Fed policy, and a benign weakening of the dollar.

According to recent data, two soft US Consumer Price Index (CPI) prints are crucial for this scenario to materialize. Failure to meet these expectations would likely lead to a Federal Reserve hike and a stronger dollar.

The European Central Bank's decision to raise interest rates in September is also expected to contribute to the strengthening of the EUR/USD, potentially reaching 1.18 by year-end. Meanwhile, unchanged Fed policy could create an opportunity for intervention to bring down USD/JPY, with some speculating that a Bank of Japan rate hike in September might be the quid pro quo for US participation in such action.

Within the G10 group, a pro-risk environment is expected to favor high-yielding currencies, particularly those with commodity exposure. The Australian dollar and Norwegian krone are likely to remain in demand, while expectations of Bank of England tightening may start to fade this autumn due to the doves at the central bank beginning to spread their wings.

Assuming a correct Fed call, emerging currencies should experience another supportive period. However, some high-yielding currencies in Latin America could be threatened by upcoming elections, particularly those in Brazil.