US equities slid on Tuesday, with the S&P down 0.4%. Bond yields US10y yields rose 5bps to 1.42% after another massive beat on US core CPI. US2yr yields rose 3bps to 0.25%.

The blockbuster inflation print could make it increasingly difficult for the Fed to stick to its position that elevated inflation metrics are nothing more than "transitory." Supply chain cost pressures continue to build, and corporates will soon pass them onto customers in an environment of such pent-up demand. Which could add to inflationary pressure? 

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But once again, the beat on the core was narrowly focussed on COVID-impacted categories; indeed 0.6ppts of the 0.9%mom rise was driven by just three: 'used cars and trucks which rose 10.5%mom (and alone accounting for about half of the core rise), 'new vehicles' up 2%mom, and 'lodging away' up 7%mom.

Will last week's fixed income rally continue to reverse as the reflation trade makes a significant return, or will investors conclude the inflation peak has been reached, and it is downhill from here? Unfortunately, I have more questions than answers on that one and feel more like an analyst than a trader this week, which is never a comfortable feeling not having a solid view. And with markets starting to enter the summer lull, which will reduce active voice flows, it will leave those of us around to go up against the machines which do not take a holiday. 

Forex

A further extension to the USD rally depends on perceptions of the Fed reaction function.

The much stronger-than-expected US June CPI has had a more pronounced impact on FX than on equity markets so far. Although US equities closed only slightly lower, the follow-through has been greater via a USD rally.

The extent to which the USD rally continues depends on investor perceptions of the Fed's reaction function. On that score, the pronounced bull flattening in the UST yield curve (2s10s or 5s30s) has not continued. 

Any hawkish tone in Fed Chair Powell's upcoming Humphrey Hawkins testimony could drive flatter curves and higher real rates, thus undercutting reflation trades,

For reflation trades to sizzle again, we will likely need a froth brew or combination of the following conditions must hold.

1. The Fed tempering taper expectations.
2. China following up last week's RRR cut with traditional interest-rate cuts.
3. A sustained recovery in non-US activity

Euro

The Euro is sitting at a support level, but the USD demand might still be in the driver's seat.

A knee jerk moved lower for EURUSD on the US CPI data, although buying ahead of the event had been the theme. The pair immediately extended more down towards the 1.1790/1.1810 support area before rebounding to 1.1835/40 but later returned to the lows as risk sentiment deteriorated into the New York close.

Remain flexible and continue to watch yields and risk assets ahead of Fed Chair Powell's testimony, where some pushback and reiteration of the Fed's transitory expectations may provide some respite. For now, though, do not look to fight the move just yet, as USD demand remains firmly in the driver's seat.

Gold will continue to zero in on real rates

Gold is lower on the more robust US inflation print because investors will start to reassess the Fed's stance. If higher inflation causes the Fed to act sooner than expected, the hawkish tilt will put gold under pressure. On the flip side, if inflation does manage to outstrip the rise in nominal yields, then gold should perform reasonably well so this market will keep an eye on real rates.

I Favor buying gold on dips here

XAUUSD held above $1800 as inflation pressures increased significantly but stayed defensive with the firmer UST yields and the dollar. Macro and retail buyers didn't find it hard to defend that level. The next upside target is at the 200-day moving average of $1826. I favor accumulating on dips to $1790 for now. Rising price pressures would continue to support gold as the inflation threat pushes real yields lower.