Currency markets remain in an induced coma

Forex markets yawn after sharp US CPI data

Currency markets remain comatose, registering barely any reaction to the US inflation data overnight. Headline inflation rose by 0.60% versus 0.40% expected. Core inflation rose by 0.70%, also versus 0.40% expected. Given that US inflation for May was considerably higher than expected, it would have been a logical step to conclude that the US dollar would have moved higher in response to the strong inflation numbers. However, this did not occur, leaving many disappointed inflationistas scratching their heads. The markets appear to have bought into the Federal Reserve’s script that higher inflation is transitory and that the Fed will stick with its dovish policy.

The dollar index eased 0.08% to 90.06 and has dropped another 0.09% to 89.98 in Asia. The fall in US yields has had zero impact on the US dollar this week, suggesting that much of the buying pushing US yields lower is offshore, balancing out the negative flows from narrowing rate differentials.

That has left EUR/USD and GBP/USD almost unchanged at 1.2188 and 1.4177 after the ECB policy decision ran exactly to an unchanged script overnight. On the other hand, USD/JPY has followed US yields lower to 109.40 and failure of 109.20 could open up deeper losses to 108.50 next week, especially if US yields remain at multi-month lows.

With the major currencies in a holding pattern, the USD/CNY is also rangebound, drifting 0.10% lower to 6.3865 today after a neutral PBOC fix and liquidity operation. Asian currencies have rallied modestly today, but with the dollar index seemingly glued to the 90.00 area, at best, we can expect more range trading from regional currencies.

Next week’s FOMC meeting is the next major risk point for currency markets. Given that they will loudly proclaim the transitory inflation mantra and keep their foot on the monetary pedal, more US dollar weakness across the board will likely be the path of least resistance next week.