Analyzing the Impact of US July CPI Data on Dollar and Global Markets Amid Disinflation Concerns

FX Daily: Is disinflation enough to get the dollar lower?

Today's release of US July CPI data will be the highlight of a quiet week. Consensus expects well-behaved 0.2% MoM readings at both the headline and core levels, providing more evidence for the Fed that inflation is coming under control. But robust US activity data and a poor overseas environment question whether the data will drag the dollar lower.

 

USD: Price action will be telling

It has been a quiet week for global financial markets. Last week's concerns about the quarterly US Treasury refunding seem to have dissipated after the three and ten-year auctions went well. In fact, last night's $38bn 10-year auction was awarded at 3.99% - i.e. investors were prepared to accept sub 4% ten-year yields after all to fund the US government deficit. Today's $23bn 30-year auction could be a little trickier. However, successful auctions and lower interest rate volatility have favoured a return to the FX carry trade. Here the world's favourite benchmark for the carry trade - MXN/JPY - is up about 1.7% since the start of the week.

Whether these benign conditions continue will be determined by today's release of US July CPI. Recall that the soft CPI releases late last year broke the back of the dollar's eighteen-month rally. Consensus expects 0.2% MoM readings for both headline and core today - consistent with inflation running closer to the Fed's 2% target. Normally we would say that this outcome would be a dollar negative - questioning whether the Fed needs to keep rates at these restrictive 5%+ levels for an extended period after all. 

However, US activity data - especially the labour market and consumption data - have been stronger than expected and are likely to keep the Fed on guard for longer. And FX price action after the recent soft 2Q23 Employment Cost Index release hinted that disinflation may not be enough to take the dollar lower on a sustained basis.  For that to happen it looks like we will need to see both softer US activity data (look out for jobless claims today)  and a much more attractive overseas investment environment than currently on offer in China or Europe today. Expect DXY to continue to trade within a 101.80-102.80 range.

Elsewhere today, look out for a Banxico policy meeting. This follows larger-than-expected cuts in Brazil and Chile over recent weeks. No change is expected, but investors are on the lookout for any hints of easing later this year. November is seen as a popular month for the first cut, but market pricing for the Banxico easing cycle is already fairly aggressive at 300bp+ for the next two years. The peso should continue to perform well, however,