Asian currencies held steady on Thursday as a broad risk-off mood offset a firmer U.S. dollar, while the yen maintained its proximity to recent highs amid expectations of an imminent Bank of Japan rate increase.
The dollar index climbed 0.2% to 99.03 at 14:38 ET, extending gains after August producer-price data came in hotter than forecast. Headline PPI rose 0.4% month over month and 5.4% year over year, both slightly above consensus estimates of 0.4% and 5.3%, respectively. Core PPI gained 0.2% monthly and 4.6% annually, matching expectations. July headline figures were revised upward to 0.1% monthly from an initially reported flat reading.
Market pricing reflected the inflation surprise. According to the CME FedWatch tool, the probability of a quarter-point rate hike by the Federal Open Market Committee on September 16 rose to 73% from roughly 64% ahead of the report.
U.S. Treasury yields surged accordingly. The benchmark 10-year yield jumped 11.8 basis points to 4.955%, while the 2-year note added 12.9 basis points to 4.556%.
José Torres, a senior economist at Interactive Brokers, said the escalation with Iran was overwhelming Washington's bond-buyback efforts, noting that soaring inflation expectations were too large a burden to be offset by $6 billion in repurchases alone. "The White House and the Treasury itself want lower interest rates, but intensifying the clash with Tehran is proving adverse to oil-price stability and the country's budget," Torres said, pointing to disrupted crude supplies and wider fiscal shortfalls from heavier military spending. He added that the environment places Fed Chair Kevin Warsh between competing pressures, as fixed-income markets are effectively demanding rate hikes to quell accelerating price pressures.
The European Central Bank, meanwhile, lifted its key policy rate by 25 basis points. ECB President Christine Lagarde flagged that the "energy shock" stemming from the Iran conflict could intensify further, with secondary effects on prices and wages potentially stronger than anticipated. The euro dipped 0.1% to $1.1614 following the decision.
Mark Wall, chief European economist at Deutsche Bank, cautioned that rapidly rising gas prices are building a negative supply shock that will eventually weigh on growth. "The question is how much and when," he said, adding that a further December hike may be more likely than not.
In commodities, U.S. West Texas Intermediate crude futures topped $100 a barrel for the first time since May 21, driven by Middle East supply concerns.
The yen traded near recent highs despite a 0.6% rise in the dollar-yen pair to 154.34. Investors looked ahead to a broadly expected 25-basis-point rate increase by the BoJ on September 18. Japan's revised second-quarter GDP growth came in at 1.4%, while foreign holdings of Japanese securities fell by a record $87.8 billion in August.
