US Dollar: CPI surprise could lift DXY toward 105 - MUFG

MUFG's Derek Halpenny notes that G10 FX volatility has decreased after a recent surge driven by higher US yields, although risks persist in the face of renewed turbulence. He links Middle East tensions, potential US involvement, and energy prices to further increases in yields and dollar strength. The September US CPI is seen as crucial for rates, with a robust print supporting further dollar gains and a higher DXY.

G10 FX volatility appears to be turning lower once more, with the dollar strengthening in response to rising sovereign bond yields. If bond yields stabilize around a new equilibrium, volatility in both rates and FX could decline. However, there are greater risks that yields could continue to rise. The US CPI data released today is highly important and will shape the immediate trajectory of rates; a weaker print would alleviate broader risks, but the current geopolitical backdrop still points to increased volatility in financial markets, which would initially benefit the dollar.

Given the Fed's expected rate hike, any positive surprise in the CPI data is likely to trigger further dollar strength. Based on our 2-year UST bond yield forecasts, the DXY could reach the 105 level, potentially driving EUR/USD below the 1.1000 mark. A consensus CPI figure is unlikely to significantly alter rate expectations, and a notable downside miss (0.0% m/m core) would be needed for a substantial dollar sell-off.