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  • Joseph Barreca

Inflation relief ahead of key inflation datatomorrow

USD: Inflation expectations fall sharply undermining the dollar


Despite the very strong jobs report that prompted a near 20bp jump in the 2-year UST bond yield on Friday, the markets failed to follow through on that move and helped trigger some reversal of last week’s US dollar strength. The 2s10s inverted further and investors added about 5bps of additional easing in H2 2023. The big data event of the week is tomorrow of course – with CPI set to remain elevated, especially at the core level – but there was some further evidence yesterday that suggested the Fed’s aggressive action is helping to influence longer-term inflation expectations. The New York Fed’s Survey of Consumer Expectations revealed a drop in the 3-year measure from 3.6% to 3.2% while over a 1-year period, the measure dropped from 6.8% to 6.2%. The 3-year drop certainly looks more compelling at this stage.

There is certainly reason to believe inflation risks are receding. Nymex crude oil is now down over 25% from the high in June and industrial metals are nearly all well lower from ytd highs (copper, palladium, platinum, zinc to name a few). However, most metals have now begun to rebound in line with equity markets and hence it remains highly unlikely that the Fed at this juncture will show any signs of acknowledging the declines in inflation expectations as progress made. That was certainly on show over the weekend when San Francisco Fed President Mary Daly and Fed Governor Michelle Bowman both suggested plenty of more tightening would be required before there was any let-up from the Fed.

2s10s curve inversion has now moved beyond -40bps and has doubled in two weeks

underlining the increasing sense of risk amongst investors of monetary overkill to

ensure that inflation risks are definitely brought under control. The surprise in that two-

week period of further curve inversion is the fact that the S&P 500 has advanced by

nearly 5% - a combination that is we believe unlikely to be sustained. Today could well be a day of consolidation ahead of the CPI data tomorrow. Given the Fed comments over the weekend and the rally in equities and some tentative signs of commodities recovering, we feel a big downside surprise would be required tomorrow to fuel a more meaningful reversal of US dollar strength – something that seems very unlikely at this juncture.


Morgan Stanley discussed the outlook for USD into tomorrows US CPI and maintain a bullish bias, expressing this view via staying short EUR/USD targeting a move towards 0.97.

"We remain bullish on the USD particularly versus the EUR, targeting 0.97. We think the market is underestimating the stickiness of US inflation, the Fed's resolve in tackling it, and the necessary tightening required to achieve lower inflation.

While US growth data may continue to slow amid softening real incomes, monetary tightening and a softening labor and housing market, rising US yields and global uncertainties should keep the USD bid as the preferred global safe haven," - Morgan Stanley

US CPI may be the critical market catalyst for the next leg of the USD rally should it exceed market expectations.


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