The Market Is Back To A USD World

The liability is now on the FOMC’s shoulders to either embrace or fight back against the back-up in front-end yields following higher-than-expected US CPI data.

If the Fed indicates less confidence in its transitory call, which I think they will, that should send real yields higher, also hurting Growth equities. In FX, higher front-end yields benefit USD on a broad-based basis.

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Trade-weighted dollar measures have pushed up to the highest levels of the year as surging US inflation makes a case for tighter monetary policy. High inflation is now a hot political topic in Washington, and both the Fed and the White House would not mind a stronger dollar right now.

No matter who will hold the steering wheel at the Fed, the decision-making of monetary policy should depend on the path of economic fundamentals, not the whims of the Chair.

Higher prices are incredibly political, and Lael Brainard suddenly looks far too dovish and too married to the Fed’s average inflation targeting framework for the top FOMC job, which is also helping the US dollar.

With any non-data-driven rallies in US bonds now looking like an excellent opportunity to sell the dip in yields, the market is back to a USD world.

EURUSD

I think the market will remain overly sensitive to terminal rate pricing, and the latest big move in the front-end US rates combined with the ECB pushes back on EU interest rates rise led to more widening and USD positive. Do I hear 1.1300? I sure do.

GBPUSD

When UST 2y yields took off from September 2017 into year-end, high-yielding currencies underperformed, and it should be no different this time around if the Fed fails to contain sharply-higher front-end yields this time around.

In G10 FX, currencies of central banks that appear behind the curve relative to high inflation breakevens in their rates markets (e.g., GBP) have the most to lose in this type of environment.

USDCAD

We warned that trading a bullish loonie from an oil proxy perspective alone generally ends in tears earlier in the week.

The narrowing of supportive CAD vs USD interest rate differential is drowning the loonie in US rate hike expectations.

If the US aggressively steps and intervenes in the oil market or even if US shale starts ramping up, I may need to revise my USDCAD 1.2600 year-end target higher.