FX Daily: Dollar struggling to shake off debasement trade

The dollar has experienced a decline of around half of the gains generated by Federal Reserve Chair Kevin Warsh's recently hawkish speech. This decline does not signal a retreat in the expectation of further Fed tightening. Currently, markets are forecasting 16 basis points for a September hike and 37 basis points for year-end. Despite the Fed support from the front end, all G10 currencies have shown an increase against the dollar on Monday.

The major reason for this shift appears to be the rise in US long-term yields, which can be attributed to higher oil prices following the recent exchange of strikes between the US and Iran. This development may indicate that markets are still interpreting the potential for Treasury intervention as a factor that contributes to the dollar's debasement.

However, it is essential to be cautious about further dollar depreciation this week, as a series of disappointing economic data releases would be required to significantly reassess September FOMC expectations after Warsh's speech. Our baseline projection remains that ISM manufacturing will stay above 55.0, while ADP payrolls will likely report 40k, ISM services will stabilize, and payroll data will be robust at 65k on Friday.

As the conviction around a September 16 hike strengthens, the dollar is expected to find support at the beginning of the month. September is also historically strong for the DXY index. EUR/USD is more influenced by the dollar as the European Central Bank is expected to raise rates again in the near future, which is widely anticipated by markets.

This scenario suggests that the euro could test support at 1.150 in the first half of September. The geopolitical tensions in the Middle East and Russia-related news are not aiding the euro's bullish outlook at present. Moreover, the surge in European natural gas prices has negatively impacted the euro's terms of trade. The Reserve Bank of New Zealand is expected to raise interest rates by 25 basis points to 2.75% tomorrow morning.

Currently, the market pricing suggests an overly hawkish stance for the NZD, as they anticipate only another 25 basis point hike for the next three quarters. This expectation may not hold true, as we anticipate CPI projections to be revised lower due to softer oil prices. Our outlook for NZD/USD is a potential decline below 0.590 in the near term, as the RBNZ may not meet hawkish expectations and the USD could find some support.

Poland's inflation rose unexpectedly in August, primarily driven by fuel prices, while food prices fell further, signaling a dovish trend in the region. Czech PMIs are due today, with wage growth expected to slow from the unexpectedly strong 8.1% in the first quarter. Turkey's August inflation is projected to decline slightly from 1.8% to 1.6% month-on-month.

Czech inflation is also slated to rise from 1.7% to 1.9%, in line with the central bank's forecast, with other CEE countries publishing retail sales data on Friday. The hawkish tone from the Fed chair's remarks and the re-emergence of tensions between the US and Iran have led to a more cautious approach from regional markets, resulting in limited further weakening and potential gains as rate differentials widen against the euro.