Dollar heads for weekly fall as investors gauge AI selloff impact

The US dollar was poised for its first weekly decline over the past month against the euro and yen, as investors scrutinized the U.S. federal reserve's rate outlook. Concurrent concerns about a potential escalation in the Iran conflict abated. AI stock prices plummeted this week, causing stress to ripple through the credit market as investors who had been heavily investing in AI-related ventures fretted about data center operators' ability to remain profitable and meet debt obligations.

Analysts posited that Wednesday's market fluctuations may exemplify how currencies would respond to a significant AI-driven sell-off, with the dollar falling instead of receiving safe-haven demand as investors pivot towards a more dovish stance on the Federal Reserve's policy path. The Swiss franc appeared set to be the primary beneficiary, fueled by its safe-haven status and the expectation that Switzerland would likely not lower policy rates below the current zero level, even in a lower-rate environment.

It was anticipated to rise by 0.61 percent against the dollar over the course of the week. The dollar index, representing the US currency against six major counterparts, dropped 0.25 percent to 101.77 and was on track for a 0.45 percent weekly decline. It had previously increased in two of the week's five sessions, including on Wednesday, as stronger-than-anticipated inflation data more than compensated for the decline in tech stocks.

The S&P 500 concluded higher on Thursday, rebounding from early losses as investors gravitated towards healthcare and consumer stocks amidst AI stock concerns. Wednesday's developments shed light on what could potentially undermine the US dollar and exert downward pressure on US yields in the coming months and into 2027: a decline in AI investment outlook, which would reduce bond supply and suppress US growth, all else being equal.

Thierry Wizman, a global forex and rates strategist at Macquarie Group, remarked, "That's because it would impair bond supply and US growth, all else equal." Meanwhile, US Treasury yields dipped earlier in the week, despite robust inflation readings, as cautious remarks from Federal Reserve officials dampened expectations of October rate hikes.

Market participants now assign an 87 percent probability to the Federal Reserve maintaining rates unchanged later this month, according to the CME FedWatch Tool. President Donald Trump was expected to refrain from escalating conflicts in the Middle East or Ukraine, as a broader confrontation could negatively impact his standing ahead of the midterm elections, potentially exacerbating inflation and destabilizing the economy.

The euro edged up 0.14 percent to $1.1235 following a 0.56 percent climb on Thursday, marking its largest daily gain in two months. It was poised for a 0.39 percent weekly increase. Should there be another substantial drop in AI stocks and risk assets in general, the dollar is expected to stabilize near recent highs, according to Chris Turner, a forex strategist at ING.

Breakdown in short-term rates would precede a dollar decline, which was not the case at present. The yen was anticipated to rise by 0.28 percent over the week, following four consecutive weekly declines, as the Iran conflict bolstered the greenback. It had risen by 0.05 percent to 157.89. Rising oil prices generally bolster the dollar while exerting downward pressure on energy-importing currencies, such as the euro and yen.

The Japanese yen experienced a mid-September slump after a disappointing Bank of Japan policy meeting but later dropped by approximately 0.30 percent weekly as authorities' hawkish rhetoric supported the yen. Governor Kazuo Ueda stated on Friday that the Bank of Japan would persist in raising policy rates in line with economic and financial developments.

The Australian dollar climbed 0.55 percent to $0.6959 but was an anomaly among currencies expected to fall against the dollar this week, as a surprisingly subdued jobs report on Thursday prompted investors to lower expectations for additional interest rate hikes.