Dollar Dips on Disinflation Trade: Impact and Potential Trends

FX Daily: Dollar drops on the disinflation trade

The downside surprise in US June CPI inflation has seen the dollar drop to new lows for the year. Over recent months we had been speculating that clear signs of US disinflation - and a weaker dollar - may emerge in 3Q23 and yesterday's moves could well be the start of an important market adjustment. Look out for US PPI and US initial claims today.

 

USD: The start of something

It has been a long time coming, but yesterday's surprisingly soft US June CPI numbers may be the first sign this year that sharp Fed rate hikes are finally starting to bite. As our US economist, James Knightley, notes, there were welcome declines in all of the key categories of inflation. He does not think this will prevent another 25bp Fed rate hike at the 26 July meeting, but it will add weight to the view that the July hike may indeed be the last in the cycle. The data could also herald a change in the Fed narrative from frustration that inflation has not fallen as quickly as expected to a more welcoming approach to recent data releases. 

We had discussed the potential FX market impact of a soft US CPI print in yesterday's FX Daily and the soft CPI has driven more benign pricing around the world - i.e. bullish steepening of yield curves, higher equities, narrower credit spreads, and a weaker dollar. FX price action has all the hallmarks of a position unwind, where those currencies sold on a bearish/hard landing scenario (e.g. Norway's krone, Sweden's krona, and to a lesser degree some other commodity currencies) have now made a very strong comeback. Indeed, both the NOK and SEK had been extremely undervalued in our medium-term valuation models and are now finding room to breathe.

For the big dollar trend, this may be the start of the long-awaited cyclical decline. There are parallels to the dollar sell-off last November and December (when it fell 8% in two months), but the difference now is; i) positioning, where speculators are not as heavily long dollars as they were last October, and ii) the China and European growth stories do not seem due as much of a re-rating as they enjoyed last November.

That said, we prefer to run with the dollar bearish story for the time being, where DXY should press big psychological support at 100.00. The next target would be 99.00 on a breakout. For today, look out for US June PPI and the weekly initial claims number. A further decline in PPI and a rise in claims could see dollar losses extend.