FX Daily: Benign CPI Takes Sting Out Of Dollar’s Upside

The DXY dollar index sold off 0.5% on yesterday's benign US CPI print and 10bp came out of the expected Fed tightening cycle. Fed officials look to be on the same page, requiring several soft inflation prints to avoid tightening, but the June data must be welcome. Today's focus will be PPI and further Fed testimony. High-yielding commodity FX should do well.

USD: Softer CPI keeps a Fed hold in play

Yesterday's release of softer-than-expected June CPI was welcomed by asset markets across the board. As James Knightley writes, the softening in prices was broad-based and is a vote in the direction of ING's house call that the Fed will not be hiking this summer after all. Yet, as Chair Kevin Warsh and many Fed members will agree, one number does not a new trend make. And another good speech from Chris Waller earlier this week serves as a reminder that the Fed will need to see 'several' soft inflation releases to avoid tightening. That explains why, even though short-dated US rates fell 10bp yesterday, the market still prices 44bp of Fed tightening into next year.

Feeding into the above story today will be the June PPI release and more testimony from Warsh. Remember that components of PPI, such as portfolio management fees, airfares and healthcare, all feed into the Fed's preferred inflation gauge of the core PCE reading. The June reading of core PCE is released on 30 June. Thus, any unwelcome rise in any of those components today could reverse more of yesterday's move in the rates and FX markets.

Overnight also saw some soft Chinese activity data and further escalation in the Gulf. It looks like investors will struggle to price in a benign inflation environment given developments in the energy sector, where both oil and natural gas are on the rise again, while refined products like diesel are surging as Ukraine intensifies its attack on Russian refineries.

While soft US CPI data has taken the sting out of the dollar's upside, it is probably too early to look for a much lower dollar just yet. In this environment, we prefer energy-exporting, high-yield currencies, such as the Norwegian krone, where a 4%+ per annum one-week deposit rate provides reward if volatility drops again in summer markets.

DXY has support at 100.50. We can see that holding while energy prices stay bid.

EUR: Unwelcome developments in the energy sector

Along with most dollar pairs, EUR/USD very much enjoyed yesterday's soft US CPI release. Were it not for developments in the Gulf and in energy markets in general, we would be happy to call EUR/USD steadily higher from here. But European natural gas is now back to levels seen in mid-March and, as above, it is too early to trade an 'all-clear' US inflation story.

In the absence of a major improvement in energy markets, we suspect that EUR/USD will struggle to break above the 1.1460/70 area and again could move down to the 1.1360/80 area should oil prices deliver another leg higher.

We do note, however, that there seems to be strong demand for EUR/USD sub 1.14. One suggestion could be a rotation into European equities as analysts raise expectations for European earnings. That may be the case, but so far those flows have not shown up in US-listed eurozone equity ETFs, e.g., the iShares MSCI Eurozone ETF.

Elsewhere, a pro-risk environment given lower prospects of Fed tightening, higher energy prices and potentially lower volatility favouring the carry trade all point to the Norwegian krone recovering some of its losses since May. We have a one-month target at 11.05 for EUR/NOK, but the move could easily extend to 10.95. We acknowledge that a soft Norwegian inflation figure this morning has lifted EUR/NOK in early Europe, but we expect good demand for the krone on dips.

CAD: BoC should show no rush to tightening

The Bank of Canada will likely keep rates unchanged at 2.25% today, in line with consensus and pricing. However, this meeting could be a litmus test for revamped hawkish bets. There is probably little incentive to openly push back against pricing for December (20bp of tightening), but the BoC has equally very few bases to argue for any earlier action. Canada’s June CPI may follow the US measure lower on falling petrol prices, potentially falling back below 3.0%. Most importantly, core measures remain very close to 2.0%.

The 2Q BoC business outlook survey showed an increase in inflation expectations, but responses were collected in May, before the reopening of the Strait of Hormuz. The latest re-escalation and improved jobs market picture should keep the BoC open to interest rate hikes, but expect the usual mention of USMCA-related concerns to add a dovish ingredient to the overall message.

We expect few changes in the policy tone by the BoC at this meeting, leaving CAD front-end rates primarily driven by developments in the Gulf. CAD should enjoy more short-term momentum if oil prices stay supported and the BoC doesn’t surprise on the dovish side. Still, a sustainable break below 1.40 in USD/CAD requires further dovish Fed inputs, while USMCA headlines may keep offering support to the pair.

CEE: US inflation brings relief to region

Today's final Polish inflation figures for June should show the full details. Inflation surprised on the downside mainly due to food and fuel prices. Core, however, remained unchanged in our estimates at 3.1%. Official core inflation figures are due tomorrow.

Yesterday, CEE FX saw a clash between higher oil prices and risk-off sentiment due to the escalation of the US-Iran conflict on the one hand and relief coming from lower US inflation on the other hand. We could see new local lows across CEE currencies but also a strong rebound after the US inflation figures yesterday. The easing of Fed hike expectations, which may be just temporary, brings relief for CEE in our view for the coming days. We therefore maintain our bullish view of the koruna and forint and expect the next few days to bring more gains here.

EUR/CZK should also be pushed down due to the hawkish Czech National Bank story locally and we could see levels below 24.200 again soon. EUR/HUF is trickier here due to the very long positioning already, but we still see a case for going lower within the current 350-360 range in our mindset, as investors see cheap levels for forint longs. EUR/PLN, on the other hand, does not see much reason to move down from current levels and we see 4.330-340 as an anchor for now.