Investors rethink the Fed's likely tightening path

In early European trade Friday, the dollar edged higher, bouncing back from a two-day slump caused by weaker inflation data than analysts had anticipated. As a result, the markets are shifting their view of the Fed's supercharged tightening path, expecting only a 50 basis point rate increase in September instead of the 75 basis points previously expected.

As surging inflation dampened consumer confidence and the Queen's Platinum Jubilee crimped business activity, the UK economy shrank for the first time in five quarters in the second quarter.

During the three months through June, the gross domestic product fell 0.1%, slightly better than expected but a sharp decline from the previous quarter's 0.8% gain.

As a result of a better-than-expected performance from industry in May and June, the figures were better-than-forecast. A drop of 0.9% in industrial output was reported instead of the 1.3% expected, and may's production was revised from 0.9% to 1.3%. Manufacturing output dropped 1.6%, while preliminary gains of 1.4% were revised up to 1.7%.

A drop in energy prices led to an unexpected drop in US producer prices (PPI) in July. It follows Wednesday's surprise announcement that consumer prices (CPI) were unchanged in July, thanks to a drop in gasoline prices, which caused the CPI to be unchanged.

It caused a short-lived relief rally in markets fearing a supercharged tightening path from the Fed. Even though the Nasdaq has bounced back from its lows in mid-June, it is still down nearly 18% year-to-date, despite its recent rebound.

With 225 basis points of Fed rate increases since March, the dollar index is up 10% this year. The dollar/yen remains steady. Since Wednesday's peak at 135.30, it had fallen to 131.75, a one-week low. A return to 133.310 was seen on Friday.

The euro has also been affected by Europe's woes. Aside from the threat of high energy prices from Russia, the European manufacturing industry must also deal with drought conditions and low levels of water on the Rhine. This is putting a strain on coal shipments, among other cargoes, and keeping European natural gas prices high. The euro remains negatively affected by this factor.