Week-long dollar drop during peak inflation

The dollar rose on Friday, but was set for a weeklong decline as traders matched improving U.S. inflation figures with comments from Federal Reserve officials who warned that the fight against rising prices continues.

According to data released Friday, U.S. import prices fell in July for the first time in seven months thanks to the lower fuel and non-fuel costs. It was the third report this week hinting that inflation may have reached its limit.

Two other key measures of inflation, consumer prices and producer prices, fell in July, data showed Wednesday and Thursday, prompting traders to question whether the Federal Reserve will raise interest rates by 75 basis points for a third straight time at its’ meeting in September.

After four days of declines, including a drop of more than 1 percent on Wednesday, the dollar rose against its major peers on Friday. Nevertheless, it is still on track for a decline of about 0.84 for the week.

Amo Sahota, director of Klarity FX said there is still cause for concern as there is not yet enough evidence that inflation has reached its’ peak or is expected to decline. 

The reversal of the dollar followed confident statements by Fed officials that the tightening policy would continue. Federal Reserve Bank of San Francisco President Mary Daley announced on Thursday that the 75 basis points rate hike in September is possible.

"The Fed would be inclined to abandon the idea of a premature policy turnaround," said Joe Manimbo, senior market analyst at Convera. "That would threaten all the hard work they've done to bring inflation down."

Traders estimated the probability of a 75-bp Fed rate hike in September at about 42.5%, and the probability of a 50-bp rate hike at about - в 57,5%.

Keith Jax, head of FX strategy at Societe Generale, referred to the dollar trade calling it "volatile." Jax argues that the dollar is not expected to fall significantly because of the current danger of Fed end-funds overvaluation.

Commerzbank said in a note that it has revised its forecast for the euro-dollar exchange rate and is leaning lower. Recession in the euro zone has now become the main scenario, rather than the risk scenario as it was before.

The bank expects the euro to fall to $0.98 against the dollar in December 2022, with the earliest possible recovery in 2023.