US Dollar: Markets remain hawkish after CPI – ING

ING strategists Francesco Pesole, Frantisek Taborsky, and Chris Turner observed that the US Dollar strengthened following an in-line Consumer Price Index (CPI), as markets had anticipated a hotter print. Despite core inflation standing at 1.6% three-month annualized, Federal Reserve expectations remained hawkish, with 9 basis points (bp) priced for September and a full 25bp hike for December.

This kept foreign exchange volatility subdued as markets prepared for the Jackson Hole Symposium. The dollar experienced a brief negative reaction to the spot-on consensus 0.1% headline CPI and 0.2% core month-on-month CPI print. The catalyst was a small dovish re-pricing in Federal Reserve rate expectations, indicating markets had positioned for a slightly hotter print than consensus.

However, the release did not provide a definitive answer for front-end rates and FX direction, and the dollar concluded the day stronger, potentially due to net long rebuilding after this round of US data. In the assessment, core inflation running at 1.6% three-month annualized weakens the case for Fed tightening. Yet, markets remain hawkish. The combination of the jobs and CPI reports has reduced September FOMC expectations by 5bp, but 9bp still exists in the price.

This indicates two significant points for FX. Firstly, there is reluctance to price out further Fed tightening, keeping dollar bulls active. Hawkish Fed communication is the primary reason. Next week's FOMC minutes will offer insights into the Committee's latest thinking. Unless there is a major surprise in today's Producer Price Index (PPI) data or other second-tier releases over the coming weeks, Fed pricing may stabilize, and FX volatility may compress further.

Nonetheless, the Fed communication is expected to gradually soften its hawkish tone, maintaining downside risks for the USD.

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