Global currency markets experienced significant volatility this week, impacted by a double whammy of US economic data. First, a continued cooling of inflation indicators dampened market expectations for a September rate hike by the Federal Reserve. Then, Friday's (August 14th) unexpectedly sharp decline in July retail sales further reinforced signals of a US economic slowdown, directly dragging the dollar index down sharply from near the 100 level, while the euro and pound sterling rose to multi-month highs. Meanwhile, the yen's rebound following the joint US-Japan intervention two weeks ago has nearly halved, with the market refocusing on the 160 level and the Bank of Japan's next move. Overall, the dollar oscillated between data and policy expectations, non-US currencies showed divergent performance, and risk sentiment and oil price volatility also contributed to the volatility.

Cooling inflation and weak retail sales have led to a loosening of expectations for dollar policy.

The biggest influence on the dollar's performance this week was undoubtedly the continuous release of US inflation and consumer data. The Consumer Price Index (CPI) cooled for the second consecutive month in July, while the Producer Price Index (PPI) unexpectedly remained flat, both pointing to a easing of inflation. Market expectations for a swift Fed rate hike have therefore significantly declined. Traders now estimate a 31% to 35% probability of a September rate hike, significantly lower than the approximately 55% a week ago. Although the likelihood of a rate hike before December remains above 60%, the urgency to "act as soon as possible" has clearly diminished. Voices within the Fed are also divided. Cleveland Fed President Hammark continues to emphasize that while inflation has improved, it is still far from the target, supporting further rate hikes to consolidate gains; Richmond Fed President Barkin believes that continued cooling inflation will help stabilize expectations, thereby reducing the need for rate hikes. A foreign exchange strategist at MUFG Financial Group points out that the Fed's core challenge now lies in balancing inflation risks with a cooling labor market, especially after the weaker-than-expected July non-farm payroll data, making a continued restrictive stance in September rather than a shift to rate hikes more likely. Friday's retail sales data dealt a more direct blow to the dollar. July retail sales fell 0.6%, far below market expectations of a slight increase, and June's data was also confirmed to show only a 0.2% increase. The clear signal of weak consumption prompted traders to further assess the Federal Reserve's policy outlook. The dollar index fell 0.33% on Friday, closing at 99.65, continuing to be pressured below the 100 level, with the weekly chart showing near flat. The euro rose 0.35% against the dollar, closing at 1.1568, having touched 1.1585 during the session, its highest since June 17, with a weekly gain of 0.1%; the pound also rose 0.36% against the dollar, closing at 1.3533, with an intraday high of 1.3561, its highest since May 12, with a weekly gain of 0.32%. Besides the data itself, the new Fed Chairman Warsh's strategy of simplifying communication also became a potential variable. The removal of forward guidance and a greater focus on current economic conditions was seen by some investors as increasing uncertainty about the policy path. Fitch Ratings’ head of U.S. economic research pointed out that without clear forward guidance, the September interest rate decision is likely to remain undecided until the last minute. Whether the rate is held steady or raised, both hawks and doves can find their own justifications in the data.

More than half of the gains from the yen intervention have been wiped out; the 160 level and the central bank's interest rate hikes are now the focus.

Regarding the yen, a joint intervention by the US and Japan two weeks ago propelled it to a rapid rise of about 5%, but this rally failed to hold, and it has since given back about half of the gains made by the intervention. The yen fell about 1% against the dollar this week, closing at 159.32, marking its largest weekly drop in three months; it also fell about 1% against the euro this week, similarly its largest weekly drop since April. Traders generally consider the 160 level a key level that could trigger a new round of official intervention, with the market betting that authorities may need to intervene again to effectively curb the depreciation. Former Japanese Finance Ministry official Mitsuru Furusawa stated that Japan might intervene "at any time" and hinted at a possible faster-than-expected interest rate hike to stabilize the exchange rate. US Treasury Secretary Bessenter urged Japan to take "policy and fundamental" measures after the joint intervention, which was interpreted as a hint that the Japanese government would soften its dovish stance and allow the Bank of Japan to raise interest rates. Strategists at OCBC Bank pointed out that the yen's decline was not surprising, as simple intervention is unlikely to change the trend; the market needs to see the Bank of Japan adopt a more explicit hawkish stance. The market now expects a 76% probability of a Bank of Japan (BOJ) rate hike in September, significantly higher than the 24% at the end of July. Analysts point out that the BOJ may raise rates as early as September and is considering a more aggressive path thereafter. Since the end of its massive stimulus in 2024, the BOJ has generally maintained a pace of twice-yearly rate hikes, raising rates to 1% in June this year. Bank of America analysts, however, caution that recent intervention has failed to reverse market sentiment towards the yen, with bearish sentiment reaching its highest level in four years. Most fund managers believe that a final interest rate of 2% is needed for the yen to stabilize, meaning the BOJ will need to raise rates several more times. If the September meeting fails to meet market expectations, the yen may face further downward pressure.

The Australian dollar received support from the central bank's hawkish stance, while the British pound's upward momentum strengthened.

The Australian dollar continued its upward trend this week, closing near US$0.7083, a weekly gain of approximately 0.27%, marking its third consecutive week of gains. It briefly hit a 10-week high of 0.7083 on Friday. The Reserve Bank of Australia (RBA) kept interest rates unchanged at 4.35% on Tuesday, but Governor Bullock delivered a more hawkish signal at the press conference, clearly stating that another rate hike was "entirely possible" if inflation failed to fall as expected. Assistant Governor Kent further pointed out on Thursday that the risks to inflation were clearly skewed to the upside, and if these risks materialized, interest rates would have to be raised further. The market expects a roughly 70% probability of another rate hike by early next year, raising rates to 4.60%, with November considered the first possible window. The chief economist of National Australia Bank expects the Monetary Policy Committee to keep interest rates unchanged and to gradually normalize policy starting from the middle of next year. The New Zealand dollar rebounded 0.67% on Friday, boosted by expectations of a rate hike, but still fell approximately 0.04% for the week. The British pound rose 0.32% this week, recording its third consecutive weekly gain. The UK economy unexpectedly accelerated its growth to 0.3% month-on-month in June, bolstering market confidence in the domestic economy. Bank of England Chief Economist Peale stated that stronger-than-expected economic growth justifies an interest rate hike. The market currently maintains its expectation of one rate hike by the Bank of England this year, but a series of inflation data to be released next week could introduce new variables. The head of strategy at CIBC pointed out that although the growth was modest, it mainly came from consumer spending and business investment rather than government spending, indicating that the UK economic momentum may be more robust than previously expected. Rising oil prices and tensions in the Middle East provided additional context for the currency market this week. Conflicts arising from US and Israeli actions against Iran, along with efforts to restore navigation in the Strait of Hormuz, led to a rise in international oil prices on Friday, providing some support for the US dollar while also increasing market volatility driven by risk aversion.

The interplay between data and policy will continue to dominate the market outlook.

Overall, this week's currency market clearly reflected the two-way influence of US economic data on the dollar: cooling inflation reduced the urgency of interest rate hikes, while weak retail sales reinforced concerns about an economic slowdown, ultimately pushing the dollar index below the 100 level, while non-US currencies, especially the euro and pound, received support. The yen continued to find a balance between the fading effects of intervention and expectations of central bank policy, with the 160 level becoming a highly watched psychological and technical barrier. The Australian dollar and the pound sterling benefited from their respective central banks' hawkish statements and improved economic data, showing relative strength. Looking ahead to next week, the market will continue to digest the July personal consumption expenditure price index and related data for August, while closely monitoring statements from Bank of Japan and Federal Reserve officials, with a focus on the Fed meeting minutes. Given the possibility of adjustments to the Fed's policy communication model and lingering geopolitical disturbances, currency market volatility is unlikely to decline quickly. Both the dollar's policy pricing and the yen's intervention and interest rate hike game require more data and official signals to confirm the direction.