Dollar Strengthens Amid Commodity Slump and Carry Trade Unwinds

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U.S. Dollar banknote is seen in this illustration taken July 17, 2022. REUTERS/Dado Ruvic/Illustration/File

On Wednesday, commodity-linked currencies experienced notable declines, driven primarily by persistent weakness in Chinese demand for raw materials. Concurrently, the Japanese yen saw a significant surge as traders recalibrated their positions in anticipation of the Bank of Japan’s (BOJ) upcoming policy meeting.

The euro maintained a stable position at $1.0848 during Asian trading hours. Meanwhile, the British pound traded at $1.2901. The pound could potentially strengthen further if the forthcoming Purchasing Managers’ Index (PMI) data from the UK surprises to the upside. Such a development might reduce market expectations of rate cuts by the Bank of England, potentially providing a boost to the pound.

In Japan, market participants are currently pricing in a 44% likelihood of a 10 basis point interest rate hike by the BOJ at its next meeting. This speculative sentiment, combined with recent instances of suspected currency interventions by the Japanese authorities, has led traders to unwind “carry trades” funded in yen. As a result, the dollar/yen exchange rate fell nearly 1% to 155.55 overnight and continued to trade around 155.78 in early Asian trading.

The yen’s appreciation was more pronounced against other currencies. The euro, for instance, depreciated by 1.3% against the yen overnight, reaching a five-week low of 168.79 yen in Asian trading. Similarly, Mexico’s peso fell by 2% against the yen overnight, and the Australian dollar has dropped almost 6% against the yen over the past two weeks. BNZ senior strategist Jason Wong in Wellington attributed the yen’s strengthening to its previously undervalued status and ongoing interventions by the BOJ. As a result, many traders holding short positions in yen are now closing out their trades in anticipation of potential changes in BOJ policy.

The broader currency market’s dynamics are also being influenced by declining commodity prices and heightened risk aversion in equities. Prices for oil, iron ore, and copper have all fallen, which has in turn negatively impacted commodity-linked currencies such as the Australian, New Zealand, and Canadian dollars relative to the U.S. dollar. Specifically, the Australian dollar hit a five-week low just below $0.6612, while the New Zealand dollar hovered near a two-and-a-half-month low of $0.5951.

The decline in commodity prices is partly attributed to disappointing Chinese growth figures released last week. The People’s Bank of China’s (PBOC) unexpected rate cuts have further spotlighted the lackluster demand for raw materials, driving key commodities like iron ore and copper to their lowest levels in three months. Consequently, the Canadian dollar fell to a six-week low of C$1.3787 per U.S. dollar. Markets are anticipating an 84% probability of a 25 basis point rate cut by the Bank of Canada later on Wednesday, which could further influence the Canadian dollar’s performance.

The U.S. dollar index stood at 104.5, approaching a two-week high, indicating robust demand for the dollar. In offshore trading, the Chinese yuan remained steady at 7.2909. As traders look ahead, key economic releases such as the U.S. GDP and core Personal Consumption Expenditures (PCE) data due later this week will be crucial in shaping expectations for potential U.S. rate cuts. Additionally, Australia’s upcoming second-quarter inflation data will be closely scrutinized for indications of future interest rate adjustments by the Reserve Bank of Australia.

In summary, the interplay of falling commodity prices, shifting central bank policies, and evolving market expectations continues to create significant volatility in the currency markets. The yen’s recent strength and the declines in commodity currencies reflect broader economic concerns and the ongoing adjustments by market participants in response to central bank signals and economic data.

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