Waller's comments suppress interest rate hike expectations, leading the dollar to drop to its lowest level since May, while the yen soars by approximately 2%.

The U.S. dollar weakened significantly on Thursday, falling to its lowest level since May of this year. Federal Reserve Governor Christopher Waller stated that inflation has made some progress and mentioned that the rate decision in September will largely depend on the August inflation data to be released next week, prompting the market to further reduce bets on a rate hike by the Fed in September. Meanwhile, the Japanese yen appreciated sharply by about 2%, becoming the strongest currency among the G10 currencies, fueled by rising expectations for a rate hike from the Bank of Japan and speculation about potential market intervention, which increased downward pressure on the dollar. The dollar fell to its lowest level since May as Wallers comments reduced rate hike expectations. Data showed that the Bloomberg Dollar Spot Index fell 0.6% on Thursday, marking the largest single-day decline in over two weeks and reaching its lowest level since May. An important catalyst for the dollar's decline stems from changes in expectations regarding Fed policy. Waller indicated on Thursday that his next rate decision will be "largely influenced" by the upcoming August inflation data. His statements regarding progress on inflation were interpreted by the forex market as a relatively dovish policy signal. As a result, swap contracts linked to the Fed's rate decision on September 16 show that the market now anticipates the probability of a 25 basis points rate hike has dropped to about 50%. In contrast, earlier this week, the market had estimated the odds of a 25 basis points hike in September to be around 70%. The significant cooling of rate hike expectations within just a few days has weakened the important rate factors that previously supported the dollar. Alex Cohen, a forex strategist at Bank of America, stated: "Waller's comments today sent a dovish signal, leading the market to moderately reduce September rate hike expectations, thereby driving the dollar lower." He further added that if subsequent U.S. employment or inflation data appears weak, it could bring greater downward pressure on the dollar. The yen surged by approximately 2% as expectations for a rate hike from the Bank of Japan heated up. Another major reason for the dollar's decline was the sudden strength of the yen. On Thursday, the yen rose about 2% against the dollar, leading the G10 currencies. Investors are further raising their bets on rate hikes from the Bank of Japan while the market remains highly alert to whether Japanese authorities may intervene again to support the yen. Previously, the yen had been suppressed by factors such as the U.S.-Japan interest rate differential and Japan's fiscal outlook. However, recent hawkish signals from Bank of Japan officials have prompted the market to reassess the path of Japanese interest rates. At the same time, the yen's recent volatility has kept forex traders on high alert, closely watching whether the Japanese government and central bank will take action to stabilize the exchange rate. Market bets on a September rate hike from the Fed have dropped from around 70% to a fifty-fifty situation. Recently, there has been a clear shift in market judgments regarding the Fed's policy path in September. Earlier, due to persistent inflation pressures in the U.S. and the hawkish signals from Fed Chair Jerome Powell at the Jackson Hole global central banking conference, investors had notably increased their bets on a September rate hike. However, the latest economic data and comments from Fed officials are changing these expectations. Waller stated that the August inflation data will have a significant impact on his policy decisions, which implies that if inflation continues to cool, he may lean toward keeping rates unchanged in September. Currently, market bets for a 25 basis points rate hike in September have dropped from approximately 70% earlier this week to about 50%, indicating a lack of clear consensus among investors on whether the Fed will continue tightening its policy. This also makes the upcoming August inflation data a crucial catalyst for determining the dollar's next direction. Market focus shifts to Fridays non-farm employment data, which may determine the short-term direction of the dollar. Before the inflation data is released, investors will first look forward to the U.S. monthly employment report set to be released on Friday. The importance of the employment data lies in the possibility that if signs of further cooling in the U.S. labor market emerge, the necessity for the Fed to continue raising rates could diminish further. The previously released initial jobless claims data has already sent some signals of weakness, prompting the market to reduce bets on a rate hike in September. If Friday's employment report again comes in weaker than expected, the market might further lower its rate hike expectations for September, continuing to depress U.S. Treasury yields and the dollar. Conversely, if the labor market remains strong and the subsequently released August inflation data exceeds expectations, the Fed's rate hike outlook may again heat up. Expectations for monetary policy between the U.S. and Japan are reversing, and the dollar faces critical data tests. Overall, Thursdays substantial decline in the dollar was not driven by a single factor, but rather resulted from the simultaneous cooling of Fed rate hike expectations and the heating up of expectations for rate hikes from the Bank of Japan. Waller's assessment of progress in inflation weakened market confidence in the Fed tightening policy further in September, reducing the odds of a 25 basis points rate hike from about 70% earlier this week to a fifty-fifty situation. Meanwhile, rising bets on a rate hike by the Bank of Japan and the market's vigilance over potential interventions have driven the yen to appreciate significantly against the dollar. Under this dual pressure, the Bloomberg Dollar Spot Index fell 0.6%, reaching its lowest level since May. Looking ahead, the dollar's trajectory will be tested by two key U.S. economic data releases. First is the employment report scheduled for release on Friday, followed by the August inflation data next week. If both employment and inflation show further signs of cooling, the market may continue to reduce bets on a Fed rate hike in September, putting greater pressure on the dollar; conversely, any significantly stronger-than-expected data could potentially alter the current interest rate pricing.