US CPI runs hot yet the USD trades lower

Firstly, the ECB has been as supportive as the equity bulls could've hoped for and the meeting left the consensus hearing a dovish tilt vs market expectations – this should be supportive of EU financial conditions in the near term and limit the appreciation in the EUR.

EURCHF shorts anyone?

(Source: Tradingview)

The US CPI print was a big number and at 0.7% MoM on core CPI, was the second-largest increase since 1981 and hotter than forecast. For anyone who read my CPI previews would recall I spoke of a world where we should've in theory, seen higher bond yields and a stronger USD on a hot CPI print – well, this theory was wrong. This subsequent move lower in US bond yields caught a lot of players off guard and while overbought the set-up on the daily looks truly bullish for bond (lower yields and higher prices), suggesting a real risk of further falls in yields. This could have bullish implications for tech and the USD, and certainly volatility – just take a look at the VIX index.

Using the VIX as a gauge, hedging equity portfolios is clearly cheap – but do funds start buying put protection because the cost is falling? It seems not - the hunt for any yield is real and the market feels the Fed has their back again – so the big funds stay long their core equity holdings, sell upside calls, collect the premium, and enhance portfolio returns. Selling volatility is all the rage again – great for investors, not so good for traders.

While the US inflation print should have seen higher bond yields, in theory. As the Treasury buyers came in Treasury shorts covered and this perpetuated the move lower – the USD fell, while Tech and Gold rallied. Given inflation expectations rose, we saw a material 9bp move lower in US 10yr real rates and I'm sure the USD would have been down far more if it weren’t for the dovish ECB.

(Source: Tradingview)

Next week the Fed meet. Will this CPI influence their thinking? I'm not so sure, but we'll see some punchy revisions to their 2021 inflation forecasts and we should hear a more open discussion about tapering its bond purchase program, albeit when they do it'll be at an incredibly slow pace.