USD: Hawkish Fed comments & higher energy prices providing tailwind

The US dollar has continued to trade on a stronger footing at the start of this week ahead of the release today of the latest US CPI report for June and the semi-annual testimony by Fed Chair Kevin Warsh before Congress. The US dollar has been supported by the pick-up in Fed rate hike expectations alongside higher energy prices. The price of Brent has extended its recent rebound hitting a high overnight of USD85.64/barrel. Tit-for-tat military strikes between the US and Iran have continued adding to concerns over the risk of more sustained disruption for energy supplies through the Strait of Hormuz. According to the United Arba Arab Emirates’ Defence Ministry, two takers were hit by yesterday by Iranian cruise missiles. Adding to the uncertainty over the passage of ships through the strait, President Trump posted yesterday that the US has reinstated a blockade of Iranian ships transiting the strait, and is now demanding a 20% reimbursement for all other cargo shipped through the water to compensate the US for providing protection. The White House has not provided other details on President Trump’s proposed charge for cargo passing through the strait, including how it would be administered or whether it had been communicated to Us allies in the Gulf. In response, Iran has declared that it has “always been the GUARDIAN of the Strait and will remain so FOREVER” while saying they will offer a better deal than the 20% charge proposed by President Trump. The Iranian government also added that the recent deal with the US has “undoubtedly entered a crisis phase” and it won’t abide by its terms as long as the other party violates commitments. 

The latest unfavourable developments in the Middle East have refocused market attention on upside inflation risks for the global economy. Short-term US yields have risen to fresh highs as market participants have moved to price in more Fed hikes in the coming years. Fed rate hike expectations have also been encouraged overnight by comments from Fed Governor Waller who stated that “if we get another hot reading on core inflation this week, then the FOMC will need to consider tightening policy monetary policy in the near-term”. He expressed concern about the “elevated pace of core inflation”. He “would be very pleased to see a lower reading on core inflation” but “will need to see several months of lower readings to feel inflation is moving in the right direction”. The comments will make the US rate market and the US dollar even more sensitive to the release later today of the US CPI for June. An upside surprise for core inflation could reinforce the US dollar’s upward momentum even if headline inflation slows due to lower energy prices.         

The top performing G10 currency overnight has been the New Zealand dollar which has also been boosted by the hawkish repricing of RBNZ rate hike expectations. After hiking rates for the first tie last week, the RBNZ’s Chief Economist Paul Conway stated that “I think developments in the Middle East over the last week suggest upside risks to our September quarter forecast”. He warned that “if inflation pressures stemming from the Middle East conflict prove to be more persistent than expected, we will respond”. The comments have reinforced market expectations that the RBNZ will deliver a back-t0back rate hike at the next policy meeting in September.     

JGBS HAVE OUTPERFORMED SINCE LATE LAST WEEK

Source: Bloomberg, Macrobond & MUFG Research

JPY: Further verbal support indicating potential shift in domestic savings

While government bond yields have risen in response to higher energy prices, it has been notable that JGB yields have fallen again overnight. The 10-year and 30-year JGB yields have dropped by 7bps and 16bps respectively. JGBs are deriving more support from verbal intervention from Japanese policymakers indicating that they will encourage domestic investors to increase portfolio allocations to domestic assets. Finance Minister Katayama spoke again overnight repeating the message from late last week that “if we successfully advance our growth strategy, yen-denominated assets will become more attractive”. When asked about changing the GPIF’s target asset allocation, she told reporters “since that’s the policy this administration is pursuing, it’s possible the portfolio could be reviewed and, if necessary, revised, as the chief cabinet secretary said”. Her comments were also backed up this time by comments overnight from Health Minister Kenichiro Ueno who stated that the GPIF’s portfolio will be reviewed if necessary. The health and welfare ministry oversees the GPIF adding more weight to his comments.

At the same time, Finance Minister Katayama highlighted that within the LPD and beyond, there have been various opinions, such as making JGBs eligible for a system like the Nippon Individual Savings Account (NISA) program that carries tax benefits for retail investors. Another idea was to exclude JGB holdings from inheritance tax rules. She stated that “while I have received petitions regarding these matters and cannot yet make a decision, I feel that the time has come to move forward with these initiatives”. According to Bloomberg, retail savings in NISA accounts have more than tripled since the end of 2020 to JPY71 trillion at the of 2025.  Taken together the comments from overnight will further encourage speculation that’s Japan’ huge savings could be better utilized to provide more support for JGBs and the yen.