The Dollar loss late yesterday is mysterious

Outlook

The dollar loss late yesterday is mysterious. The risk-off sentiment from war uncertainty “should” have sent the dollar higher. That it didn’t might be down to oil rising dramatically and the old inverse correlation with the dollar re-emerging. That correlation had gone away when the US became a much bigger producer and exporter, but maybe it’s back.

There are dozens of academic essays online about this weird relationship but they are not actually very helpful. The only decent chart online is from MacroMicro. It looks like it ends in 2025 but it does end on July 8.

Nobody can say how long this will last or even if it will last. You might think that if oil keeps going up, the dollar will keep going down, but that’s not the message from the chart, which shows them more in sync than in an inverse correlation. 

The Fed minutes were no help at all—until you dig down. The June policy meeting saw the govs split down the middle about raising rates—despite many speaking of higher prices and also of the Fed having overshot their inflation target for five years. The minutes themselves were not as abbreviated as had been feared, cut by only about 20% (but it’s early days).

The reporting tries to make straw out of hay, imposing uncertainty on what is really just a 50-50 vote. We say the 50-50 vote is not uncertainty. Saying nothing would be uncertainty. We already knew from the dot-plot that 9 of 18 fall on the side of a hike likely needed, so tweaking words is a bit annoying. “A few” would have liked to raise at the June meeting, but agreed to hold fast for this meeting. "Most participants" agreed to a scenario in which inflation will fall on its own; but others expect inflation to remain high. This is the group of unknown numbers that would prefer a rate hike if higher inflation persists.

The staff forecasts are more like it. Here is the Mish version: “The staff’s inflation forecast for this year and the next was higher than the one prepared for the April meeting, reflecting incoming data, higher energy prices and other input costs due to the conflict in the Middle East, and the effects of the AI buildout on consumer prices. 

“Total inflation was projected to slow over the second half of this year from its recent pace, as retail gasoline prices were expected to decline, although core inflation was forecast to change little over the rest of the year. Inflation was projected to step down next year, as some of the factors lifting inflation this year—such as tariffs—were expected to wane, and then move down further to about 2 percent in 2028.”

Mish adds some more of special note: if inflation falls, “almost all of these participants noted that it would likely be appropriate to maintain or eventually lower the target range for the federal funds rate.

“Most participants, however, also pointed to scenarios in which, in the context of stable labor market conditions, inflation would remain elevated due to strong AI-related demand, the conflict in the Middle East, or the effects of tariffs. In such scenarios, almost all of these participants indicated that some policy firming would likely be warranted to return inflation to 2 percent.“

So, the minutes refer to “a few” or “most participants” but these two entries of note indicate no, they have their heads screwed on right. This time it’s “almost all” or “most participants” expect inflation to persist ands a hike to be needed.

The bettors didn’t miss the juicy stuff. By 5 pm yesterday, the probability of s hike at the Sept meeting had moved from 40.8% a week ago to 52.2%. If you add in those who see more than one hike, it rises to 69.2%.

Forecast

We lack guidance on what to expect from the Iran war. Trump says talks are useless but outright war is not on the table, except when he says it is--"Anything that happens is going to be over very quickly ... and will only make it safer, including for ​oil.”

The oil market seems to believe him, which is itself remarkable. Oil prices are on the calm side and not gyrating with every message or the seeming threat of ongoing war and the Strait being closed. We said yesterday “watch oil” but didn’t expect this!

The crux of the matter is still the Strait and Iran charging a toll—unless the US blockades the exit again. As Reuters points out, you’d think a higher risk premium is needed and would be reflected in crude prices.

We are at sixes a*nd sevens. Anyone who says he knows which way any price is going is lying. You can design a scenario for each of several possible outcomes. As before the first time around, we worry about the oil market failing to respond appropriately to the threat to the supply chain disruption.

We’d prefer not to offer trading recommendations. The dollar rose on rising oil prices yesterday, but then gave up on a small retreat in oil. We would have to see more of the same—falling dollar--depending on how the oil gang responds to whatever comes next in the Iran war.

Fun Tidbit: Trump told SecTreas Bessent to halt all trade with Spain. Economist Krugman threw a fit. It would be like the EU saying “halt trade with Florida.” Of course it can’t be done and of course it’s nuts, a foolish demand from a vain and childish man who is besotted with what he thinks is his power, a great deal of which he doesn’t actually have.

You have to wonder what Bessent is thinking. 

Krugman deduces there is something wrong with the country that nobody is screaming bloody murder about it. But while that may be true, it’s also true that we are accustomed to irrationality and grandiosity from this guy, and we all know he will be gone in less than three years, so why bother? Nobody can change him now and we just need to hunker down and bear it. We might get some relief at the midterms, 117 days away. Or we wait for the 2028 election, 852 days away.

Food for thought

Does the US have a somewhat demented, incompetent and dishonest president? Yeah, the probability is leaning that way. And to the point, everyone knows it. Europe is seeking to de-Americanize. China knows it. Iran knows it.

The foreign affairs experts say that Trump can’t do full-out war for all the reasons already enumerated and anything less still leaves the Strait under Iranian control and the US a failure. Not only a failure, but a rogue nation not to be trusted.

The world’s policeman has turned into the worlds’ biggest crime syndicate since the East India Company, which you will recall ended in ignominy and bankruptcy, rescued by the UK government but still with outstanding debt until the UK just gave up and “extinguished” the debt during WW II. In other words, over 300 years after its founding in 1600. Oh, dear.