US CPI inflation data was much higher than expected with a 12-year high headline rate of 5.4%.

US CPI inflation data was much higher than expected with a 12-year high headline rate of 5.4%.

US Treasuries pared initial losses but selling increased later in the day with yields higher after a weak auction. Equities were relatively resilient, but overall risk conditions were more fragile amid tightening fears. Wall Street stocks posted limited net losses with Asian markets weaker.

The dollar posted net gains on interest rate expectations and traded close to 3-month highs. EUR/USD dipped below 1.1800 amid dovish ECB expectations. Sterling was mixed as dollar moves dominated with GBP/EUR testing 3-month high after higher-than-expected UK inflation data. Commodity currencies retreated amid the firm US dollar, but pared losses on Wednesday after a hawkish RBNZ statement.

The dollar edged higher ahead of Tuesday’s market open with the Euro drifting lower amid caution and position adjustment ahead of the latest US inflation data.

The US NFIB small business optimism index strengthened to 102.5 from 99.6 previously with further upward pressure on costs.

US consumer prices increased 0.9% for June after a 0.6% increase the previous month and well above consensus forecasts of 0.5%. The year-on-year rate increased to 5.4% from 5.0% and above market expectations of 5.4%. This was the highest headline annual rate since September 2008.

Underlying prices jumped 0.9% on the month after a 0.7% increase previously and well above forecasts of 0.4%. The annual rate increased to 4.5% from 3.8% and the highest rate since October 1991. There was a further surge in the price of used cars for the month with a 45% annual increase while overall energy prices increased 1.5% over the year with a 24.5% annual increase. There was also further upward pressure on rents and the data triggered further debate over the inflation outlook.

Following the data there was a further retreat in Fed Funds rate futures with market close to fully pricing in an increase in interest rates by the end of 2022 with expectations that tapering plans would be brought forward which underpinned the US currency.

The dollar posted sharp gains in an initial reaction to the data with EUR/USD dipping below the 1.1800 level. The US currency partially retraced as yields edged lower, but there was renewed dollar buying later in the session as EUR/USD retreated again to lows near 1.1780 with the dollar testing 3-month highs. Fed Chair Powell’s testimony will be watched very closely on Wednesday for further evidence on Fed thinking. The dollar maintained a firm tone with EUR/USD close to 3-month lows near 1.1780.

St Louis Fed President Bullard stated that the time is right to pull back on stimulus measures with the economy in a good position to start a tapering of bond purchases, especially with some concerns that the central bank is feeding a housing bubble.

US Treasuries moved lower in an immediate reaction to the US CPI data, but the overall reaction was muted and yields quickly moved back to little changed. Equity futures were also broadly resilient despite limited net losses and initial USD/JPY gains were held to just above 110.50.

San Francisco Fed President Daly stated that it was time to talk about tapering which fuelled further expectations of a shift in the internal Fed debate.

After paring gains, there was renewed dollar support after the European close with long-dated Treasuries declining sharply after a week 30-year auction. US yields moved significantly higher with the 10-year yield above 1.40% and USD/JPY moved to near 110.60.

Japan’s monthly Tankan index recorded a 30-month high in the manufacturing sector, but there was deterioration within the services sector as coronavirus concerns persisted. USD/JPY was unable to hold the gains on Wednesday and drifted to around 110.50 as US yields edged lower with EUR/JPY holding above 130.0.

Sterling was unable to gain further traction in early Europe on Tuesday with a cautious tone following the Bank of England financial stability report as the bank warned that risks to the economy remain and some asset prices were elevated. Governor Bailey also warned that there was sensitivity to higher borrowing rates in weaker parts of the economy. Overall risk appetite held broadly steady which helped limited selling pressure on the UK currency.

There were also still reservations over developments surrounding the Delta variant which could triggered a policy U-turn over the next few weeks.

The headline UK inflation rate increased to 2.5% for June from 2.1% and above consensus forecasts of 2.2% with the core rate increasing to 2.3% from 2.0%. Sterling gained amid expectations of a more hawkish Bank of England tone with a GBP/USD move to 1.3840 and GBP/EUR rallied to 3-month highs around 1.1730.

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