Dollar Weakens Slightly on Labor Data

The dollar index cut modest gains to trade slightly lower at 99.5 on Wednesday as investors digested the latest ADP employment report. US private businesses added a net 38,000 jobs in August, the weakest increase since January and below expectations of 47,000, pointing to a broader cooling in the labor market. Despite the soft data, the greenback remained near a two-week high as investors sought safety amid concerns over the economic impact of the energy shock and diverging monetary policy paths across major economies. The US said it had launched overnight airstrikes on targets in Iran, prompting retaliation from Tehran in the most serious escalation between the two countries in weeks. Meanwhile, markets are pricing in a 66% probability of a September Fed hike, significantly higher than around 40% a week ago, according to the CME FedWatch Tool.

The dollar index rose above 99.7 on Wednesday, reaching its highest level in nearly three weeks as surging oil prices intensified inflation concerns and reinforced expectations for an imminent Federal Reserve interest rate hike. Oil prices advanced for a third consecutive session amid escalating hostilities between the US and Iran, raising concerns over further disruptions to energy flows from the Middle East. Meanwhile, Fed Chair Kevin Warsh’s commitment to combating inflation strengthened bets for a rate increase, with markets now pricing in around a 70% chance of a move this month. Fed Governor Michael Barr also said on Tuesday that the central bank should be prepared to raise interest rates if inflation fails to ease. Attention now turns to the ADP employment report due Wednesday and nonfarm payrolls on Friday for further clues on the Fed’s policy path.

The dollar index rose to above 99.6, extending the rebound from the three-month low of 98.8 from August 21st, and tracking the surge in yields across the curve inflationary risks aligned with the outlook of a more hawkish Federal Reserve. The US and Iran reignited attacks against each other and further dimmed the small prospects that energy flows through the Strait of Hormuz could improve in the near term. The rise in energy prices added to inflationary pressures shortly after a series of FOMC members, including Chairman Warsh, warned that inflation could warrant a rise in interest rates. The Chairman also noted that the labor market has been under full employment recently, aligned with annual revisions to nonfarm payrolls that were well below recent downgrades. In the meantime, evidence of higher inflation in the Eurozone added to the consensus of an ECB rate hike, limiting the rebound for the DXY.