USD flows: USD gains on higher than expected CPI

US CPI comes in much stronger than expected at 0.5% m/m headline and 0.4% m/m core, but the core increase was also close to 0.5% (0.446%). The strength was quite broad based, and has pushed US yields up significantly , with rise of 10bps across the curve. There is now only one Fed rate cut priced in for the year, and it isn’t fully priced until December.

The rise in yields is naturally USD positive across the board. In recent history, higher yields have tended to be most positive for USD/JPY, as there has usually been a bigger move in US-Japan spreads than US-Europe spreads as a result, with European yields tending to rise with US yields. This has initially been the case this time around, with the JPY slipping a little lower on the crosses. But we are sceptical that this impact will persist, as higher inflation and less Fed easing will also have a negative impact on equities, and this tends to be JPY supportive. While the equity decline so far has been quite modest, there is a risk of a much larger move lower as when yields rise due to higher inflation rather than stronger growth, the implications for equities tend not to be positive, and we are starting from extremely expensive levels (in the US). We are also coming from a starting point where USD/JPY was already outperforming yield spreads after sharp overnight gains, so gains above 154 might prove hard to sustain.

For EUR/USD, the widening of front end yield spreads and softer equities keep the risks on the EUR downside, although underperformance of US equities will tend to limit the EUR decline, and progress sub-1.03 is still likely to be hard to achieve. Commodity currencies will typically suffer in this more risk negative conditions, but there may be some offset, particularly for the CAD, if higher inflation is seen as reducing the risk of tariffs as these would further boost inflation.