US dollar hardens pp ahead of the Fed after CPI headaches boost Treasury yields

The US dollar has made multi-year highs against several currencies this week as well as a 20-year peak on the DXY index, a US dollar index most watched by markets.

This is due to the fallout from the US CPI number last Friday that spooked markets into fears that the Federal Reserve is losing control over price rises throughout the economy.

As a result, today’s Federal Open Market Committee (FOMC) meeting takes centre stage.

Long term chart USD (DXY) Index, USD/JPY, GBP/USD and AUD/USD

The headline CPI number of 8.6% year-on-year to the end of May beat the 8.3% anticipated. The absolute level of it is worrying enough, but of most concern is the re-acceleration of rising prices.

Overnight we saw PPI print at 10.8% for the same period instead of 10.9% forecast. Although PPI was a slight miss, the problem remains that higher costs for producers and companies are potentially coming down the pipe and into CPI.

Businesses can either absorb the higher costs and reduce profitability or pass on the costs to consumers. In a free-market economy like the US, passing on rising costs is the option most favoured.

This is the danger that is lurking for the Fed and has led to an increase of market expectations for a rate hike today from 50 basis points (bps) to 75 bps. The language in the post meeting press conference will be scrutinised closely for clues on the path of future hikes. If the commentary isn’t as hawkish as the market desires, the tail risk of hyper-inflation could become a mainstream risk.

All of this extra lifting in rate hike expectations from the Fed has led to Treasury yields racing higher across the curve. Elevated interest rates have boosted the US dollar. Going into today’s meeting, the option market reveals a scramble toward insurance on a higher USD against EUR, GBP, AUD, NZD and CAD via risk reversals.

They are showing an increasing preference for puts (sell) for these currencies against USD calls (buy). CHF and JPY risk reversals are more neutral against USD. Clues could be found in the reaction to Fed actions and words for future USD direction.

US dollar (DXY) index technical analysis

The DXY has eclipsed last month’s peak to make a fresh 20-year high overnight. The next historical high that may offer resistance is at 109.77 from September 2002.

Momentum appears to be bullish with positive gradients on all short, medium and long-term simple moving averages (SMA). Making this high saw the price move outside the upper band of 21-day SMA based Bollinger Band.A close back inside the band could indicate a potential reversal.

Support might be at 10- and 21-day SMAs, currently at 103.46 and 102.83 respectively.

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