Dollar may correct further if US Fed delivers 75 basis point hike

Ravindra Rao, VP - Head Commodity Research at Kotak Securities

Commodities continued to sway to the tune of the US dollar reflecting the increasing importance of the currency in times of economic uncertainty. The next major test for the currency is the US Fed's monetary policy decision on July 27 and uncertainty will prevail till then.

Gold held in a range near $1,700 per troy ounce at the start of the week before sliding to March 2021 lows and then bouncing back close to $1,715 per troy ounce. NYMEX crude topped $100 per barrel before a sharp correction later in the week. LME copper moved closer to $7,500 per tonne but struggled to hold on.

Commodities started the week on a firmer note as US dollar index succumbed to profit taking amid debate about the pace of rate hikes by Fed. The sharp slide in euro and Japanese yen made them susceptible to short covering ahead of Bank of Japan and European Central Bank (ECB) decisions.

The US currency saw a brief rebound as we moved closer to central bank decisions but struggled to build on gains. The currency lost momentum as mixed US economic signals highlighted stress in the economy and as ECB joined other central banks in monetary tightening.

ECB raised interest rate for the first time in 11 years and surprised some with a 0.5 percent hike to bring inflation under control. The central bank maintained a hawkish stance and promised further hikes possibly as soon as its next meeting in September. ECB's stance briefly pushed euro to a two-week high against the dollar but it lost momentum soon.

Yen also held on to the gains even as Bank of Japan kept monetary policy unchanged as expected and expressed support for accommodative stance. Japan, however, expressed concerns about rising inflation and lowered growth estimate.

US economic data highlighted increasing challenges for the economy making a case for Fed to slow down the rate hikes. US weekly jobless claims rose to the highest level in eight months. Philadelphia Fed's July factory activity index contracted for the second straight month in July. Leading indicators index fell for the fourth straight month adding to debate about a recession.

The US dollar index has come off highs and is struggling for momentum, however, there is still no major change in outlook for the currency. The US Fed is expected to lead other central banks in monetary tightening which may keep the dollar supported. Additionally, global growth concerns are intensifying and this may also keep safe haven demand high for the US currency.

The next major test for the dollar is Fed’s monetary policy meeting on July 26-27. While there has been a lot of discussion about the pace of rate hike, Fed is largely expected to raise interest rate by 0.75 percentage point at the upcoming meeting and this has been factored in.

The choppiness in dollar and stability in equities show that market players are expecting the Fed to stabilise the rate hike cycle due to some signs of easing price pressure and increasing risks for the health of US economy. If the Fed sticks with the 0.75 percent hike, it will send a signal that the central bank is not looking for more aggressive moves, in which case we may see additional correction in the dollar, which may support commodities at large.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.