US dollar under pressure with September hike questioned

I find it funny how quickly the market outlook changes. With two devaluations by China in as many days, all of a sudden the potential for a rate hike in September is being questioned. the Chinese yuan has weakened by 3% against the dollar in those two days. Does this give the excuse the doves on the FOMC need to justify holding off from a September rate hike now? 

china down

Over the course of the past few weeks, somehow it had gone from September being still just a potential month for when the Fed was going to start interest rate hikes, to becoming supposedly almost a nailed on definite. I have said numerous times that I did not agree with this view (I am still saying December) and think that the Fed will find enough excuses to hold off next month. And yet commentators on media (both written and television) have been stating with near certainty their views that the Fed would move in September. We have now had two devaluations by the People’s Bank of China which has seen the Dollar/Yuan rate over two days jump from 6.21 to now stand at 6.38 (or a weakening of around 3% in the yuan).

Even today there was a gentleman on CNBC suggesting that it was not 100% for sure that the Fed would move in September. I find this remarkable, as this infers that it was previously 100%. I say this a lot, but the Fed has a dual mandate and whilst the unemployment data may be favorable, inflation certainly is not. The China devaluation will only help to make Chinese imports into the US cheaper and therefore the US will be importing disinflationary forces. This also at a time at which commodity prices continue to tumble and wage growth remains stagnant. This will give the doves on the FOMC who may be wavering (such as Stanley Fischer) an excuse to stand pat on their rates decision.

I have talked about the long end of the US yield curve flattening in recent weeks. This has been exacerbated by the sharp flight into US Treasuries in the wake of the China devaluation. Look at the US 10 year yield which fell early today to a three month low. This is not the chart of a bond market that is confident of the longer term prospects of growth and it would be surprising if the FOMC did not raise an eyebrow or two when glancing at this chart.

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This chart and the changing perceptions of a September rate hike has had significant implications also for the strength of the US dollar today. The sharp reversal on some of the forex majors could now begin go question how sustainable these dollar bull runs are going to be. Also the volatility in the past few days suggests that traders are in a state of heightened uncertainty.

  • EUR/USD has broken out to a one month high as the euro has rebounded. This has ended a sequence of lower highs and really is beginning to question the medium term outlook once more.
  • Dollar/Yen has reversed from a breakout yesterday. The near term support now between 123.50/124.00 is key.
  • On the commodity currencies, the AUD/USD and NZD/USD both hit multi-year lows this morning before sharp intraday recoveries have set in. Neither pair has achieved anything yet in terms of significant technical recovery moves, but are certainly worth watching now.

And finally, look at the gold price. A correction on the dollar will tend to be gold positive. Add in the flight away from risk trades and this adds up to a bounce on gold. The near term move above $1105.60 completes a small base pattern that implies a rebound right back to the crucial resistance of the old key support at $1131.85.

There certainly seem to be a near term move away from the dollar. If the market concludes that this does indeed mean that the FOMC will avoid hiking in September, then the move could go for a little while further.

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