The dollar weakened on Monday (September 29) amid concerns over a potential government shutdown, with the yen outperforming the euro ahead of a series of US economic data releases that could provide further clues about the direction of Federal Reserve policy.

The dollar strengthened last week following economic data that pushed down expectations for a Fed rate cut. Traders now expect the Fed to ease policy by 40 basis points in December and a total of 105 basis points by the end of 2026, about 25 basis points lower than the levels seen in mid-September.

US GOVERNMENT SHUTDOWN PARTIALLY SUBSTANTIAL

The dollar index, a measure of its value relative to a basket of foreign currencies, fell 0.14% on Monday to 90.04, after rising 0.5% last week. Investors are primarily concerned about the possibility of a US government shutdown if Congress fails to pass a funding bill before the fiscal year ends on Tuesday.

Without a funding bill, the government will partially shut down on Wednesday, the first day of fiscal 2026. Analysts say the dollar typically weakens ahead of such events, before strengthening once the funding dispute is resolved. Markets will likely view this as a new drag on an already sluggish labor market.

The government shutdown will impact the release of the closely watched non-farm payrolls report on Friday, as well as subsequent economic data, which may not be released. Ahead of Friday's employment report, investors will also get data on job openings, private payrolls, and the ISM manufacturing PMI, among other things.

"The Fed's shift in response function from inflation concerns to labor market defense, leading to faster and earlier rate cuts and lower real interest rates, but at the expense of higher-than-expected inflation, suggests we will remain in a regime of U.S. dollar weakness for longer," said David S. Adams, head of G10 FX strategy at Morgan Stanley.

LEGAL BATTLE OVER FED GOVERNOR COOK

Investors are also closely watching the legal battle over the potential dismissal of Federal Reserve Governor Lisa Cook, as any threat to the Fed's independence poses a far greater risk to the dollar than a government shutdown.

The Trump administration has asked the U.S. Supreme Court to allow President Donald Trump to fire Cook, arguing that her dismissal would be a legitimate exercise of presidential authority. The euro strengthened 0.11% to $1.1713, while sterling gained 0.18% to $1.3425. Analysts expect inflation data from eurozone countries to have little impact on the outlook for interest rates or the single currency, as investors expect policy to remain stable. Spain's 12-month inflation rate, harmonized by the European Union, rose to 3.0% in September.

Analysts' attention remains on the war in Ukraine and the potential for increased military spending. Against the yen, the dollar weakened 0.5% to 148.77, after strengthening more than 1% against the Japanese currency last week. However, the divergence in interest rate outlooks will remain a focus amid signs of a hawkish shift on the Bank of Japan's board.

"We favor a short position in the dollar/yen," said Mohit Kumar, an economist at Jefferies, adding that he expects more rate hikes from the BoJ. "Furthermore, for some Asian countries, offering off-ramps to allow their currencies to appreciate could be part of trade negotiations with the US," he added.

In other currencies, the Australian dollar was last up 0.22% at $0.6561. The Reserve Bank of Australia (RBA) will announce its interest rate decision on Tuesday. The central bank is expected to leave interest rates unchanged. (alg)

Source: Reuters