The dollar index (DXY00) on Thursday rose +0.42% as the strong US PPI report sparked a pull-back in expectations for Fed rate cuts in the coming months.  In addition, San Francisco Fed President Mary Daly and St Louis Fed President Alberto Musalem both threw cold water on the idea of a -50 bp rate cut at the September FOMC meeting.  The dollar's interest rate differential improved with the 10-year T-note yield rising +5 bp and the 2-year T-note yield up +6 bp.

Thursday’s PPI report was much stronger than market expectations.  The PPI report suggested that the markets might have been overly optimistic about Tuesday's CPI report and that companies are passing through tariffs at the wholesale level at a higher pace than earlier thought.

The July US final-demand PPI report of +0.9% m/m and +3.3% y/y was substantially stronger than market expectations of +0.2% m/m and +2.5% y/y.  The July US core final-demand PPI report of +0.9% m/m and +3.7% y/y was substantially stronger than market expectations of +0.2% m/m and +3.0% y/y.

The markets dialed back expectations for Fed easing in the wake of Thursday's disappointing PPI report. The markets are no longer discounting any chance of a -50 bp rate cut at the September meeting and are now assigning a 93% chance of that rate cut.  After Treasury Secretary Bessent's interest rate suggestion to the Fed on Wednesday, the markets temporarily assigned an 11% chance of a -50 bp rate cut at the September meeting.  Nevertheless, the current 93% chance of a -25 bp rate cut in September is still substantially more dovish than the 40% chance assigned before the news of the weak July payroll report on August 1 and the in-line CPI report this past Tuesday.

US weekly initial unemployment claims fell by -3,000 to 224,000, which was close to expectations for a slight decline to 225,000.  US weekly continuing claims fell by -15,000 to 1.953 million, which showed a slightly stronger labor market than expectations of a dip to 1.967 million.

San Francisco Fed President Mary Daly told the WSJ that she does not support a -50 bp rate cut at the September meeting, saying that "would send off an urgency signal that I don't feel about the strength of the labor market." Ms. Daly said she still supports two rate cuts this year, but that three cuts could be warranted "if we saw more signs that the labor market was more precarious."

St Louis Fed President Alberto Musalem said that a -50 bp rate cut at the September meeting would be "unsupported by the current state of the economy and the outlook for the economy" in his view.  He said it is too early for him to make a decision on a rate cut at the September meeting.

Treasury Secretary Scott Bessent Thursday tried to backtrack a bit on his statements on Wednesday in which he said interest rates are "too constrictive" and that rates "should probably be 150, 175 basis points lower." He added, "There's a very good chance of a 50 basis point cut.  We could go into a series of rate cuts here, starting with a 50 basis point rate cut in September." 

In an interview with Fox Business Thursday, Mr. Bessent said he was not telling the Fed what to do and that he was not calling for a series of Fed rate cuts with his comments on Wednesday.  He said he was merely trying to say that models show the neutral rate is lower, although he didn't specify which models he was referring to.  Mr. Bessent said he supports transparency and the call to clean up investment conflicts among members of Congress.

The markets are awaiting this Friday's Trump-Putin summit in Alaska for any progress in ending the Russian-Ukrainian war.  President Trump on Monday downplayed expectations of a breakthrough, saying the summit is a "feel-out meeting" to end the war in Ukraine. Also, recent comments from Ukrainian President Zelenskiy dampened hopes for a quick end to the war when he rejected any talk of Ukraine ceding territory to Russia.

In recent tariff news, President Trump early Tuesday extended the tariff truce with China for another 90 days until November.  Last Wednesday, Mr. Trump announced that he will impose a 100% tariff on semiconductor imports.  Still, companies would be eligible for exemptions if they demonstrate a commitment to building their products in the US.  However, the US will levy a separate tax on imports of electronic products that employ semiconductors.  Also, Mr. Trump announced last Wednesday that he will double tariffs on US imports from India to 50% from the current 25% tariff, due to India's purchases of Russian oil.  Last Tuesday, Mr. Trump said that US tariffs on pharmaceutical imports would be announced "within the next week or so." According to Bloomberg Economics, the average US tariff will rise to 15.2% if rates are implemented as announced, up from 13.3% earlier, and significantly higher than the 2.3% in 2024 before the tariffs were announced.

Federal funds futures prices are discounting the chances for a -25 bp rate cut at 93% at the September 16-17 FOMC meeting and at 53% for a second -25 bp rate cut at the following meeting on October 28-29.

EUR/USD (^EURUSD) fell -0.49% due to dollar strength. Also, sentiment on the euro remains cautious due to the negative impact of US tariffs on the European economy.  Meanwhile, market expectations are low for any significant progress at Friday's Trump-Putin summit in Alaska, which suggests that the Russia-Ukraine war is likely to drag on and continue to dampen sentiment in the Eurozone economy.

Swaps are pricing in a 7% chance of a -25 bp rate cut by the ECB at the September 11 policy meeting.

USD/JPY (^USDJPY) rose +0.27% due to strength in the dollar. The yen saw some underlying support after US Treasury Secretary Bessent said the Bank of Japan is falling behind the curve in addressing inflation and that he expects a rate hike.  However, the yen continues to be undercut by concern that US tariff policies will harm the Japanese economy.

December gold (GCZ25) on Thursday closed down -25.10 (-0.74%), and September silver (SIU25) closed down -0.533 (-1.38%).  Precious metals prices closed lower due to the higher dollar and the rise in T-note yields that accompanied Thursday’s hawkish US PPI report.

Gold continues to have safe-haven support related to US tariffs and geopolitical risks, including the conflicts in Ukraine and the Middle East.  Fund buying of precious metals continues to support prices after gold holdings in ETFs rose to a 2-year high on Tuesday, and silver holdings in ETFs reached a 3-year high last Friday.