ING: USD: Lots of focus on real yields - FJElite

Last night's FOMC press conference was a little confusing. Looking at the market's reaction, the conclusion was that the Fed was not going to be as tough on fighting inflation as initially thought and might try to wriggle through this period of high inflation without hiking. Chair Kevin Warsh's celebration of higher real yields and the more 'direct' message from the markets was taken as a view that the Fed had outsourced monetary tightening to the markets, reducing the need for hikes. To be honest, we are not sure if that is the correct read or whether Warsh implicitly acknowledged that higher real rates embodied an expectation that the Fed would hike in September.

But the market reaction clearly reflected a Fed potentially going soft on inflation, with a huge 14bp steepening in the 2-30 year Treasury curve and US 30-year mortgage rates pushing above 6.70%. Break-even inflation rates derived through the 5Y5Y inflation swap rose 6bp as well.

Having risen 60bp since the June FOMC meeting, two US real yields fell 7bp yesterday and undermined the dollar. Presumably, we will not receive much of a steer from the Fed before its September meeting, and it will be the data which determines whether the Fed will hike. Bond vigilantes could also have a say as well, if a sell-off in the long-end accelerates and the Fed is forced to anchor the short-end with a hike.

For today, the focus will be on the first look at 2Q GDP data (expected at 2.0% QoQ annualised) and the core PCE inflation data for June. The latter is expected to have slowed a little, with core PCE at 0.2% month-on-month and the year-on-year rate dropping to 3.3% from 3.4%. Any downside surprises here could hit the dollar given the emerging view that the Fed is trying to avoid tightening.

DXY probably risks a correction back to the 100.50 area and the two sets of CPI prints and jobs data before the 16 September FOMC meeting will determine whether DXY has topped for the year.