Currencies tread water as Middle East risks temper rate cut optimism

British Pound

FXStreet: GBP/USD inches higher following the easing of the concerns about an imminent broader conflict in the Middle East have diminished following an exchange of fire between Israel and Lebanon's Hezbollah that did not escalate further. US Air Force General C.Q. Brown, chairman of the Joint Chiefs of Staff, told Reuters early Tuesday after concluding a three-day trip to the region. The risk-sensitive GBP/USD pair trades around 1.3190 during Tuesday’s Asian hours. The US Federal Reserve Chairman Jerome Powell stated at the Jackson Hole Symposium on Friday, "The time has come for policy to adjust."

However, Powell did not specify when rate cuts would begin or their potential size. According to the CME FedWatch Tool, markets are fully anticipating at least a 25 basis point rate cut by the Federal Reserve at its September meeting. Additionally, San Francisco Federal Reserve President Mary Daly stated on Monday in an interview with Bloomberg TV that "the time is upon us" to begin cutting interest rates, likely starting with a quarter-percentage point reduction. Daly suggested that if inflation continues to slow gradually and the labor market maintains a "steady, sustainable" pace of job growth, it would be reasonable to "adjust policy at the regular, normal cadence."

In the United Kingdom, the BRC Shop Price Index fell by 0.3% year-on-year in August compared with the previous increase of 0.2% in July. British shop prices fell in annual terms this month for the first time since October 2021, pushed down by summer sales of clothes and household goods. UK Prime Minister Keir Starmer stated last week that addressing Britain's numerous challenges will take time, warning that "things will get worse before they get better" in a speech he described as an opportunity to be candid with the public.

As Britain's parliament returns to work after the summer break on Tuesday, Starmer may emphasize that "change won't happen overnight," but his government is committed to tackling a wide range of issues, from overcrowded prisons to long waiting lists for health services.

US Dollar

Reuters: The dollar edged higher on Tuesday and major currencies traded sideways as lingering concerns over tensions in the Middle East partially offset investors' optimism for imminent U.S. interest rate cuts. Geopolitical risks kept early currency moves subdued, though fears of an escalating conflict following Israel and Hezbollah's major missile exchange over the weekend petered out. The yen was last 0.2% lower at 144.82 per dollar, giving up some of its safe haven gains from the previous session which saw it rise to a three-week high of 143.45 per dollar.

The euro and sterling dipped slightly to $1.1161 and $1.3182, respectively, though both weren't far from their recent multi-month highs. The Canadian dollar was little changed at 1.3487 per U.S. dollar, having scaled a five-month peak overnight as oil prices surged. "The market is sort of taking a breather and waiting to see key data releases," said Rodrigo Catril, senior FX strategist at National Australia Bank. "Given also that we have kind of second-tier data releases this week, it plays to the view of a sort of more rangey environment over the near term."

Still, major currencies were holding near milestone highs and the dollar near its lowest level in over a year, helped by the likelihood of a U.S. rate cut in September after Federal Reserve Chair Jerome Powell more or less nodded to such a move in his Jackson Hole speech on Friday. San Francisco Fed President Mary Daly also said on Monday a quarter-percentage point reduction in borrowing costs next month was likely. Against a basket of currencies, the greenback was last 0.05% higher at 100.90, languishing near a 13-month low of 100.53 hit in the previous session.

The Fed's aggressive rate-hike cycle and expectations of how much further U.S. rates could rise had been a huge driver of the dollar's strength over the past two years, keeping other currencies, particularly the Japanese yen, under pressure. "The question now is no longer whether the Fed is going to cut in September but by how much," said David Chao, Invesco's global market strategist for Asia Pacific ex-Japan. "Powell left the door open for larger cuts in case labour conditions deteriorate. Investors believe that the Fed appears to be open to cutting rates faster than previously expected."

Markets have already fully priced in a rate cut next month, and see about 100 basis points worth of easing by the end of the year. Elsewhere, the Australian dollar eased 0.05% to $0.6768, though remained not far from a one-month high of $0.67985 hit on Friday. The New Zealand dollar edged 0.08% lower to $0.6199, but similarly strayed not too far from Friday's high of $0.6236, its strongest level in over seven months.

South African Rand

Reuters: South Africa's rand was stable on Monday, ahead of local economic data releases this week that could give hints on the health of the local economy. At 1608 GMT, the rand traded at 17.7150 against the dollar, near its Friday closing level of 17.7100. The rand, like most emerging market currencies, benefited from a softer dollar on Friday after comments from Federal Reserve Chair Jerome Powell solidified bets of a September rate cut.

South African investors will focus on monthly producer inflation, money supply, budget and trade balance data due later this week for signs on the health of Africa's most industrialised economy. On the stock market, the Top-40 index closed down 0.33%. South Africa's benchmark 2030 government bond was weaker, with the yield up 1.5 basis points to 9.085%.

Global Markets

Reuters: Asian stocks fell on Tuesday as investors pondered looming U.S. interest rate cuts and awaited earnings from AI darling Nvidia, while rising tensions in the Middle East and supply concerns checked risk sentiment and lifted oil prices. Gold prices were just shy of a record peak, while the dollar firmed and the yen hovered near its highest in three weeks as investors sough safety amid geopolitical risks, with Israel and Lebanon's Hezbollah exchanging fire on Sunday. Also supporting crude prices was Libya's eastern-based government announcement of the closure of all oil fields, which halted production and exports.

Investors are on edge ahead of Nvidia's earnings report on Wednesday, where anything short of a stellar forecast from the AI chipmaker could jolt investor confidence in the AI-fuelled rally. MSCI's broadest index of Asia-Pacific shares outside Japan was 0.36% lower on Tuesday, inching away from the one-month high it touched in the previous session. Japan's Nikkei eased 0.16%, while Chinese stocks were also on the back foot. China's blue stock index CSI300 fell 0.28% while Hong Kong's Hang Seng index was 1% lower in early trading, dragged by lacklustre earnings from Temu-parent PDD Holdings due to lower consumer spending.

Also weighing on sentiment was the move by Canada, following the lead of the United States and European Union, to impose a 100% tariff on imports of Chinese electric vehicles and a 25% tariff on imported steel and aluminium from China. In an eagerly awaited speech, Federal Reserve Chair Jerome Powell on Friday endorsed an imminent start to interest rate cuts, putting the focus on the Fed's September meeting. "With the Fed now firmly in the driver’s seat, the markets will be on an intense data watch," said Gary Dugan, CEO of the Global CIO Office.

Investor focus will be on the U.S. personal consumption expenditure price index - Fed's preferred gauge of inflation - due to be released on Friday and then the August payrolls report next week. Markets are fully priced for a 25-basis-point cut from the Fed next month, with 100 bps of easing anticipated in the next three meetings of the year. Mansoor Mohi-Uddin, chief economist at Bank of Singapore, said Powell did not clarify the size of the Fed’s upcoming rate cuts noting it "will depend on incoming data, the evolving outlook, and the balance of risks."

"We continue to see the Fed making two 25 bps rate cuts this year to the benefit of risk assets. We think a 50bps cut next month is only likely if the payrolls report shows another jump in unemployment." The yen was a shade lower at 144.67 per dollar, giving up some of its safe haven gains from the previous session which saw it rise to a three-week high of 143.45 per dollar. The dollar index, which measures the U.S. currency against six rivals, was last at 100.84, close to a 13-month low of 100.53 it touched in the previous session.

Oil prices took a breather in early trading on Tuesday after rising 3% in the previous session due to supply concerns in the wake of escalating tensions in the Middle East and production cuts in Libya. Brent crude futures were 0.45% lower at $81.06 a barrel, but not far from the two week high of $81.58 it touched on Monday. U.S. crude futures eased 0.5% to $77.01 a barrel but remained close to a one-week high of $77.60 it touched overnight. Gold prices eased to $2,511 per ounce on Tuesday just shy of the record high of $2,531.60 reached on Aug. 20.

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