The fact remains that re-opening the Strait is the single most important factor

Outlook

Most folks attributes the dollar gain to the rising price of oil that is based on the falling probability of the Strait getting re-opened. Bloomberg goes so far as to blame Trump rhetoric—see the chart at the end. Historically, oil and the dollar are inversely correlated and it’s the supply shock that is upending that relationship.

The fact remains that re-opening the Strait is the single most important factor, even to the exclusion of a nuclear deal or ending Iranian and Houth attacks on neighbors (or heaven only knows what’s going on in Israel). This has been the case all along and even Trump knows it. He cares about the midterms just enough to want the price of US gasoline to fall, and for that, he needs the Strait.

Therefore, we must expect the next move will be conciliatory and aim for a resolution, at whatever cost. And as noted before, re-opening the Strait is the single biggest dollar headwind. Reuters summarizes well: “Tehran's demands that Washington lift⁠sanctions, pay reparations and allow it some control of Hormuz were countered by the White House's insistence on Monday that Tehran pay compensation of ​its own and free up all shipping lanes.

“Oil markets are bracing for a protracted standoff, adding to persistent inflation worries, nudging bond yields higher ​and reining in stocks, despite the bumper second-quarter earnings season. At 5.28%, the yield on the 30-year Treasury bond came within a whisker of its highest in almost 20 years.”

But the biggest dollar tailwind is the prospect of a rate hike, and for that, we look to tomorrow’s inflation data. It is likely a small drop, even if current affairs point to an increase down the road.

Forecast

Some wise guy wrote last week that Fed chairman Warsh has two bosses, Trump and the bond market. Trump has restarted the domination fire with a fresh attack on Board member Cook, and the bond market is deeply, seriously unhappy about the inflation outlook, and that gets a boost every time Trump blunders in the Iran war situation.

The dollar generally follows the yield, if not one-for-one and not immediately, and the exceptions are noteworthy. We need to watch the yield curve tomorrow and to hell with economic analysis—the change in yields will tell the whole story. We could, however, get a standoff—weaker inflation but no real drop in yield, at least not at the longer end. That leaves FX traders in limbo, pretty much the same as the Iran war talks.

Tidbit: The dollar remains the numeraire and top reserve currency, with the Chinese currency far behind. But… the FT reports Deutsche Bank has just become the first big Western bank to clear renminbi. Eeek.

We continue to think, as we wrote in the FX Matrix with co-author Schmelzer, China has a tough row to hoe because the communist law and mind-set put all property rights in the State. Individuals and institutions do not have property rights unless the state “gives” them.  We expect this to come about sometime soon, like 3 months to three years.