US core inflation meets expectations.

US consumer prices increased 0.1% for May compared with consensus forecasts of 0.2% and the year-on-year rate declined sharply to 4.0% from 4.9%. This was slightly below market expectations of 4.1% and the lowest reading for just over two years.

Food prices increased 0.2% on the month with an annual increase of 6.7%. Energy prices declined 3.6% on the month with an annual decline of 11.7%.

Core prices increased 0.4% on the month which was in line with consensus forecasts and the annual increase also met expectations at 5.4%. There was the second successive monthly increase of over 4.0% for used vehicle prices which pushed the rate higher.

There was a net shift in Fed Funds rate pricing with the chances of a rate hike at Wednesday’s meeting cut to below 10%. The chances of an increase in July were also cut slightly to around 65%.

Treasuries posted gains immediately after the US inflation data, but there was a sharp reversal later in the session with the 10-year yield jumping to near 3.85%.

The German ZEW economic confidence index edged higher to –8.5 for June from –9.4 previously and slightly stronger than expectations of –11.9.

Overall volatility levels remain low while equity markets posted net gains and bond yields increased. In this context, markets maintained a strong interest in carry trades which undermined the yen.

Bank of England Governor Bailey stated that the latest jobs data shows a very tight labour market and that inflation had been slower to fall than the central bank had hoped.

MPC member Dhingra stated that inflation is still far too high relative to the target and that monetary policy is likely to be slow to take effect.

UK Gilts were subjected to heavy selling on Tuesday following the latest UK wages data. The 2-year yield surged to 15-year highs just below 4.90%. UK GDP data met expectations with 0.2% growth for April.

The Federal Reserve will announce the interest rate decision on Wednesday. Consensus forecasts are for rates to be left on hold at 5.25% with relatively hawkish rhetoric. The statement and Chair Powell’s press conference will be very important with a notable focus on Powell’s guidance. There will also be updated ‘dot plots’ of interest rate forecasts by the individual committee members.

The Euro held firm into Tuesday’s US inflation data. EUR/USD posted 3-week highs just above 1.0820 after the US data before fading.

The dollar regained ground as US yields moved sharply higher. EUR/USD settled just below 1.0800 on Wednesday.

The yen was undermined by higher US yields and gains in equities as markets ploughed into carry trades. USD/JPY posted strong gains to 1-week highs around 140.20.

The Swiss franc overall edged lower. EUR/CHF settled around 0.9775 with USD/CHF settling around 0.9050.

Sterling was boosted by the surge in UK bond yields. GBP/USD posted 1-month highs at 1.2625 with only a slight correction.

Commodity currencies overall were mixed. AUD/USD settled around 0.6770 with some support from Chinese rate cuts. The Canadian dollar was underpinned by a rebound in oil prices. USD/CAD dipped to 4-month lows below 1.3300 before recovering to 1.3310.

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