The dollar heads for its worst week in three months: the credibility of the Federal Reserve is in doubt, and Japan's massive intervention strikes again.

The dollar is heading towards its worst week in three months. Doubts about the new leadership of the Federal Reserve's commitment to curbing inflation continue to fester, combined with suspected record-scale intervention by Japanese authorities in the yen, pushing the dollar to a low not seen in over a month. The Bloomberg Dollar Spot Index saw a cumulative decline of up to 1.2% this week; although it rebounded slightly on Friday due to end-of-month capital flows, the overall weakness was evident. The core of this round of dollar decline lies in market anxieties about the leadership of Federal Reserve Chairman Kevin Walsh. Recent statements from Walsh have raised concerns among investors that the central bank may hesitate to raise interest rates while inflation remains above target. This worry is directly reflected in asset prices: long-term U.S. Treasury yields, seen as indicators of inflation expectations, have surged to their highest level since 2007. However, contrary to usual patterns, the dollar has weakened instead of strengthening. This unusual correlation between bonds and the dollar has been described by Randall Prakash, Managing Director at Gavekal Wealth, as having a "somewhat 'emerging market' feel." He pointed out that investors are beginning to express dissatisfaction with the policy path in the United States, which is "negative for both U.S. Treasury bonds and the dollar." Despite the latest economic data released on Thursday providing a rationale for the Federal Reserve to hold steadyshowing a slowdown in U.S. economic growth in Q2 and a 0.1% month-on-month decline in the core personal consumption expenditures price index favored by the Fedit has not dispelled the clouds hanging over the dollar. As of Friday, the swap market is still pricing in a cumulative increase of 34 basis points in interest rates by the Fed for the remainder of the year, remaining roughly flat compared to Thursday. Francesco Pesole, a foreign exchange strategist at ING, stated, "We are still not in a hurry to judge that this round of dollar selloff has hit bottom. Any U.S. data that falls short of expectations could lead to a larger scale of dovish repricing than before." Japanese "surprise" in the forex market, selling off $53 billion in a single day As the dollar's momentum weakened, the suspected strong intervention by Japanese authorities became another straw breaking the camel's back. During the New York trading session on Thursday, the yen surged 3.3% against the dollar within a few hours, marking its largest single-day increase since December 2023, peaking at 158.34, distancing itself from the 40-year low around 164 set earlier in the week. The dollar experienced its biggest single-day drop since the end of 2022 at that time. Although Japan's Finance Ministry officials declined to confirm whether an intervention had taken place, multiple pieces of evidence suggest this was a well-orchestrated surprise operation. Based on a comparison of changes in the Bank of Japan's accounts and predictions from currency brokers, analysts estimate the scale of this intervention to be about 8.45 trillion yen, or approximately $528 billion. This may likely set a record for the largest single-day intervention in Japan's history. Citigroup's sales and trading division noted in a report to institutional clients that its electronic trading platform recorded about $8.1 billion in dollar-yen sell orders within just ten minutes from 9:30 AM to 9:40 AM Eastern Time on Thursday. Daisaku Ueno, Chief Foreign Exchange Strategist at Mitsubishi UFJ Morgan Stanley Securities, stated, It's hard to imagine what else could cause the yen to plunge 5 points in such a short time other than currency intervention. He believes that the authorities deliberately chose to act between the Federal Reserves and the Bank of Japans meetings to catch the market off guard. There are market reports indicating that South Korean authorities also sold dollars during the New York session, allowing the won to reach its strongest level since mid-October last year, raising speculation about coordinated actions between the two countries. Jun Mimura, Japan's top foreign exchange official, hinted that the authorities' actions are gaining support from other countries, including the United States. According to a person familiar with the matter, U.S. authorities conducted a "currency review" around 2:30 AM Tokyo time on Friday, a move typically seen as a precursor or supporting action for coordinated intervention. After the intervention, the market's focus shifts to the prospects of the Bank of Japan and the dollar Following a brief artificial price surge, the durability of the yen's trend remains to be tested. On Friday, the Bank of Japan maintained its interest rates as expected, leading the yen to give back some of its overnight gains, trading around 160 at the time of writing. This intervention marks the second significant action taken by Japan this year. Previously, during the Golden Week from late April to early May, authorities had made a record 11.73 trillion yen intervention in the foreign exchange market in a single month, but the yen quickly retraced its gains thereafter. For the yen, the real market battle will unfold in the Bank of Japan's policy communications. If the market interprets that the central bank's future interest rate hikes will be slower than expected, the current benefits of the intervention for the yen may rapidly evaporate. Hiroshi Saito, an executive advisor at SBI FX Trade, remarked, The key is whether the authorities will continue pushing for the dollar to fall below the 155 level. We hope to use this to gauge the government's determination to defend the currency. As for the overall trend of the dollar, with the market reassessing the Federal Reserve's policy path and becoming more sensitive to U.S. economic data, any shifts in fundamental conditions could intensify volatility. After Japan has drawn a "red line" with real money, the dollar may soon face dual pressures from policy actions and overseas official forces.