Forex: All Eyes Are On Service Inflation

The 10-year US Treasury yield has settled back in the 4.25% to 4.30% range, but USD/JPY continues its upward trajectory, driven by carry trade enthusiasm.The market is looking for an excuse to push US yields lower and keep the S&P 500 rally wagon rolling; Tonight’s CPI report will be pivotal in determining if this happens.All eyes are on service inflation, the sticky element that keeps the Fed patient. And with the Algo’s in full swing, remember those decimals will count.In contrast to the US, eurozone markets do not foresee a rate-cutting cycle. EUR/USD now appears to be more aligned with movements in rate spreads. The narrowing of the 2-year EZ-US swap spread is consistent with the rise in EUR/USD. Market fears of a significant surge in volatility due to a sell-off in OATs are easing, where the OAT-Bund 10-year spread has been stabilizing around 65bp. As a result, the drop in US yields exerts more influence on European currencies and the pound. However, this is pushing EUR/JPY and GBP/JPY higher and further pressuring USD/JPY upwards, all via carry trade appeal.Despite repatriation smoke signals from the GPIF and an expected narrowing between US Treasury (UST) and Japanese Government Bond (JGB) yields, the substantial yield differential continues to favor a long USD/JPY position.Regarding the CPI report, traders see a two-way risk to US inflation. On the one hand, tighter monetary conditions and a softer labor market could help bring inflation down. On the other hand, the recent 15% increase in WTI oil futures and an 11% rise in gasoline futures prices could lead to higher monthly headline inflation in the July reports if there aren’t offsetting improvements elsewhere.Markets are currently pricing in two US rate cuts this year, with a 75% chance of the first cut happening in September. It’s like a financial tug-of-war, with traders anxiously watching to see which side wins.Meanwhile, the DXY USD index remains firm at around 105, while US equities have reached record highs.The dollar’s next move will hinge on the CPI report and its implications for the Fed’s rate decisions. If inflation shows signs of cooling, we might see a push lower in US yields and a subsequent sell-off on the dollar. Conversely, any signs of persistent inflation could reinforce the current stronger US dollar trendsMore By This Author:A High-Stakes Game Of ‘Guess The Future’
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