Dollar Strength Holds Firm

MACRO FRAME

The US and Iran have agreed to a framework deal to end their conflict, reopen the Strait of Hormuz, and move toward broader negotiations—though major issues (Lebanon conflict, nuclear program) are not fully resolved yet.

STOCK INDEX FUTURES

Equity index futures were mixed overnight following yesterday’s sharp losses, led by a sell-off in tech and semiconductor names globally. Micron earnings today will be in focus as a near-term catalyst for the tech space, being seen as a bellwether for AI demand and the sustainability of the semiconductor rally. Some of the recent volatility in the tech space can be attributed to flow-driven volatility related to SpaceX flows and boom-bust price action in the semis as well as pressure from expectations of Fed tightening. Rising concerns over heavy capex and the sustainability of AI-driven valuations also remain present after SpaceX announced it would be tapping the bond market to raise cash. Recent declines in the stock (not a part of the Nasdaq) have triggered broader concerns that big tech may be spending too much on AI infrastructure and that spending using debt is too high. Still, the move reflects a correction in sentiment and profit-taking as the risk-reward profile of the tech space shifts amid more of a crowded trade. On a positive, oil prices continued to move lower as tanker traffic through the Strait picks up.

Watch point: The Fed’s recent policy meeting has led markets to expect a hike in October. However, a sustained drop in the price of oil could challenge some policymakers views of whether tightening could be necessary. Still, policy is biased to a move upwards, while today’s sell-ff reinforces the case for selectively adding some defensive positioning to the ongoing tech‑led momentum.

CURRENCIES

US DOLLAR: The USD index is 0.37% higher to 101.78. The dollar retains firm support from a hawkish shift in Fed policy expectations and the strongest net long in dollar positions in over 16 months, according to the CFTC. Traders are placing around a 68% chance of a hike in September and are fully priced for a hike by October. The dollar is has been driven more by rates and macro factors than geopolitical developments over the last couple of sessions, as falling oil prices and direct US-Iran talks would otherwise see a flight away from dollar safety. Still, ongoing geopolitical uncertainty and Iran’s willingness to close the Strait are limiting the downside to the dollar.

Watch point: A durable peace agreement and drop in oil prices is likely to unwind expectations of Fed policy tightening, though the FOMC meeting presented a sharp reversal in recent market dynamics, with the dollar now finding stronger support against foreign currencies.

EURO: The euro is 0.50% weaker at $1.1327. The euro is being dragged down by comments from European Central Bank President Christine Lagarge, who downplayed the effects of second-round inflation worries, suggesting that the bank is likely to take a balanced approach to policy in the future. Expectations of a rate hike from the ECB have now been pushed back to December from earlier pricing of an October rate hike. This dynamic is likely to further dollar strength against the euro. For the ECB, policy is likely to remain biased upwards, though a continued easing in services inflation could dull some expectations of a move upwards. The euro is likely to benefit from risk-on flows away from the dollar, though increased expectations of Fed tightening, a sharp reversal from earlier dynamics, now offer fresh pressure against the euro.

On the data front, The Composite PMI came in at 49.5, up from 48.5 in May, beating consensus of 49.1. This marks the third consecutive month of contraction for the eurozone private sector, though the pace of decline is the weakest so far in that run. As for the prices index, input cost inflation eased to its slowest pace since just before the outbreak of war in the Middle East, with lower energy prices filtering through to businesses. Output price inflation also slowed, though by less than input costs. The employment index was little changed. Most responses were collected before the US-Iran ceasefire MOU was signed on June 17, meaning the data doesn’t fully capture any demand or sentiment uplift from that development.

Watch point: A peace deal, restoration of oil flows through the Strait, and easing services inflation are likely to push back tightening expectations, though policy expectations are still biased upwards.

BRITISH POUND: Sterling fell 0.39% to $1.3150. Andy Burnham looks set to become the new Prime Minister lending focus to who the pick to become finance minister will be. Current finance minister Rachel Reeves is likely to leave her role if Burnham becomes PM, media outlets reported on Tuesday and Wednesday, with pro-business former health secretary Wes Streeting among the names tipped for the job. Broadly, the leadership succession is likely to have little effect on the pound as an orderly transfer of power looks set and as markets have priced in Starmer’s exit for some time. Still, markets remain highly sensitive to fiscal credibility, particularly given the UK’s elevated borrowing costs and structurally weak growth backdrop. For now, the rate backdrop is likely to be the significant driver in price action for the pound. Bank of England Governor Andrew Bailey said that it remains too early to call off the inflation risk during the BoE’s most recent meeting. Looking ahead, the bar for further tightening appears high and contingent on renewed energy or expectations, while a sustained easing in inflation and confirmation of a softer labor market would keep the debate focused on how long policy must stay restrictive rather than any tightening. Recent inflation and GDP data have supported our view that the BoE has limited scope to tighten policy and that money markets are overzealous in pricing rate hikes from the BoE.

JAPANESE YEN: The yen was little changed overnight at 161.75 yen per dollar. The yen is trading near 40-year lows, a break above the 161.96 level would take it to its weakest level since 1986. Volatility in the yen should be expected from traders as the currency faces intervention risks from the government.  Fed pricing toward tighter policy, persistent rate differentials against Japan, and the lack of effectiveness of prior interventions without a sound Bank of Japan backdrop all continue to pressure the currency. Despite Japan’s Ministry of Finance signaling willingness to intervene, market skepticism of that effectiveness, largely resulting in a intervention vs. hawkish Fed and strong US data trade.

The BoJ’s recent rate hike offered the yen no support despite rates being at their highest level in 31 years. With policy rates in Japan still deeply negative in real terms, incremental moves are unlikely to deliver a durable yen rebound. Instead, markets are increasingly focused on Japan’s heavy debt load, while political support for a weaker yen, equity benefits from FX depreciation, and reluctance to tackle the debt overhang suggest any sustained yen strength will require more than rate hikes alone. The market sees a total of 20 bps of tightening by year-end. The yen has now sustained a break above the 160 support level.

AUSTRALIAN DOLLAR: The Aussie fell 0.32% to $0.68958, holding near 11-week lows as dollar strength weighs on the currency. Headline Australian CPI fell 0.7% MoM in May (bigger drop than expected), pulling annual inflation down to 4.0%, but trimmed‑mean core rose 0.4% MoM and accelerated to 3.6% YoY, keeping underlying price pressures elevated. Recent pressure against the Aussie has come from stronger Fed rate hike pricing, which has led to a compression in interest rate differentials. Still, progress in US-Iran talks are largely supportive of the risk-sensitive currency. Markets are pricing around a 65% probability of another hike from the Reserve Bank of Australia this year. The Bias for the RBA remains toward further tightening as the bank is seen as having a lower threshold to hike again, particularly if growth and labor data continue to prove resilient. Labor data on Thursday will be key watch items for the path of AUD and the trajectory of the RBA. If both data sets surprise to the upside, a hike from the RBA is likely. Downside surprises are likely to null any expectations of RBA tightening.

Watch point: While a durable end to the war would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to keep the RBA on a tightening path.

TREASURY FUTURES

Yields inched lower across the curve amid the drop in oil prices. Still, yields have remained higher in the face of the hawkish shift in Fed expectations. The hawkishness has been driven by resilient economic data, sticky inflation, and a perceived hawkish reaction from Chair Warsh. The consensus market pricing of around 36bps of hikes in 2026. The BofA is among a minority of firms calling for additional tightening by year end. Still, the recent Fed meeting has reinforced upward pressure on front-end yields, which has significantly compressed the 2/10 spread to 26 bps from 40 bps seven days ago. The key tension remains a more hawkish Fed reaction function and market pricing, leaving Treasuries vulnerable to further repricing if incoming data supports the Fed’s tightening bias. Tomorrow’s PCE data will be the highlight of the week. Warsh characterized the inflation overshoot as supply-driven rather than demand-driven, leaving room for yields to eventually ease if oil prices continue to hold a substantial drop.

Watch point: The Warsh-led Fed held on rates and signaled broad institutional change. Mainly, markets should expect fewer words from the Fed and less policy signaling, raising near-term rate volatility with incoming data.

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