Monthly Foreign Exchange Review

Summary:

USD sentiment is negative heading into September, due to a sluggish US economy combined with moderate inflation. Lower inflation numbers may give Fed Chair Warsh room to push the planned 25bps hike out past December, which is weighing on the USD. USD debasement became a prominent discussion in August as the USA passed $40T in total debt. Oil remains a wild card for inflation and economic growth, but most analysts think energy prices will remain in control in the US. Another wild card is the size of the US Treasury buyback program—if it is larger than expected, this could be extremely USD negative. Once again, macro risks remain elevated in September, even if we haven’t seen them materialize over last several months.

USD WEAKNESS

Oil market macro risk remains high despite moderate oil prices. Oil and gasoline prices remain at odds, with the crack spread remaining above $60 a barrel. Diesel prices remain elevated. China moderately returned to buying oil in the open market, and analysts expect China to return to full volumes in Q4. Analysts estimate 12-15m barrels are making it out of the countries formerly reliant on the Strait compared to the 15-20m pre-war. The oil supply shock has been smaller than expected, still we are missing 5m/day of supply.

The US labor market is sputtering in 2026. The most recent jobs report showed the US lost 23k jobs, and total jobs created for 2026 sits at 406,000. This is far lower than we would expect with a strong economy. The unemployment rate fell, but only because the labor force participation rate fell to a 5-year low. Average hourly earnings rose only 0.1% The labor market is weak and expectations for the 9/3 report is to gain only 55k jobs.

US inflation moderated but remains above target. Nearly every data release came in lower than prior months for August, but we are still not at the Fed’s 2% inflation target. Core PCE was 3.3%, this is the preferred inflation gauge but was up 0.2% month-over-month. Core CPI was 2.5%. Inflation numbers remain above the 2% target, but they are slowing. Consumers expect prices to remain elevated, but barring a large spike in oil, inflation is slowing.

US short term rates have priced in a hike by December, but will the Fed actually pull the trigger? The Fed has two mandates – full employment and low inflation, and right now the US has low unemployment but above target inflation. All new fed chairs face the question: Are they “tough enough” to raise interest rates? New Chair Warsh is under more scrutiny than most due to his fluid stance on rates over the years. Still, if inflation numbers continue to come in lower and Core PCE can get below 3% in the next 2 months, there may be some room for the fed to avoid a rate hike in 2026.

US Treasury Secretary announced a doubling of the US Treasury buyback program. On August 19, the announcement briefly shocked markets, causing a stock market sell-off and long-term rates to touch levels not seen since the Global Financial Crisis. Markets quickly normalized after digesting the details of the announcement, this program seems much smaller and more contained than the shocking headline. Stil, the tone shift seems real, and grumbling about deficits and long-term fiscal sustainability is everywhere.

The USD weakened in August, and sentiment is USD negative for September. After grinding stronger in July, the USD was hit by a trifecta that all led to a weaker USD in August: The Bessent buyback announcement, the Canada tariffs situation, and weaker than expected inflation all lean USD negative. More broadly, fears of US Dollar debasement have rattled the markets after the US passed $40T in total deficits. All this together caused the current negative USD sentiment across the globe. Watch this carefully: If inflation comes in closer to the 2% target in September, the rate hike odds shifting lower would be quite USD negative. In August, the USD lost 2% broadly against most major currencies, and this could easily continue in September.