Fiscal Risks Weaken Dollar as Fed Hike Odds Plummet

US Dollar (USD) bulls are facing a new challenge as softer inflation and labour data have eroded the yield support for the currency. According to DBS Group Research economist Philip Wee, the weaker US CPI reading kept the DXY Index locked in a narrow range of 99.4-100.1 after the recent USD/JPY sell-off triggered by joint US-Japan interventions.

The markets have sharply reduced the implied probability of a September Federal Reserve hike to 40% from 72% at the end of July, driven by last Friday's negative nonfarm payrolls and slower CPI inflation readings. Wee noted that the average hourly earnings were modestly lower, which suggests that Fed officials will be less concerned about a repeat of second-round effects of inflation that emerged after COVID-19.

The weakening fiscal position of the US is also undermining the yield advantage of US bonds, supporting the USD. This trend may continue to weigh on the currency's value in the coming months.