Market Overview

On Monday, the USD index experienced little movement during the North American session, primarily due to the absence of significant U.S. economic data. This lack of activity kept the dollar under minimal pressure. With summer liquidity affecting the markets and no major U.S. data releases expected until Thursday's crucial CPI numbers, the USD is anticipated to remain within a narrow trading range. However, economic data from the eurozone and the UK could introduce some volatility.

Inflation and Market Expectations

A report from the New York Federal Reserve hinted at persistent inflationary pressures. Notably, June's year-ahead earnings growth reached its highest level since September 2023. While one-year inflation expectations dipped slightly to 3% from 3.2%, the three-year outlook rose to 2.9% from 2.8%. This suggests that inflation concerns remain, influencing market sentiment and expectations.

Currency Movements

The EUR/USD, a major component of the USD index, fell by 0.2% during the North American afternoon, slipping from earlier highs of 1.0845. Meanwhile, GBP/USD hit a new four-week peak at 1.2846 before settling slightly lower at 1.2825. The USD/JPY pair traded between 161.05 and 160.48, with resistance encountered just above 161, prompting caution among USD bulls about potential intervention.

Treasury Yields and Equities

U.S. Treasury yields saw a modest increase, causing a slight inversion in the yield curve, with 2- to 10-year yields rising by 2-3 basis points. This yield movement erased early equity gains, which had reached new record highs. The NY Fed data contributed to the rise in yields, leading to declines in gold, silver, and bitcoin.

Market Sentiment and Fed Expectations

Market participants are eagerly awaiting Fed Chair Jerome Powell's congressional testimony on Tuesday, although it is expected that he will mainly reiterate the Fed's recent progress on inflation and its strategy of waiting for further progress towards the 2% target. According to LSEG's IRPR page, there has been minimal change in Fed rate expectations. Futures indicate a 20% chance of a 25 basis point rate cut in July and an 80% chance in September, with nearly two 25 basis point cuts expected by the December 18 FOMC meeting.

Risk-Off Sentiment

In a risk-off environment, investors tend to retreat to safer assets such as government bonds and gold, often spurred by concerns over economic stability, geopolitical tensions, or disappointing economic data. This shift results in a decrease in equity markets and a potential strengthening of the dollar as a safe haven. Currently, rising Treasury yields and persistent inflation fears are driving such sentiment, as investors seek stability amidst uncertain economic conditions.

Risk-On Sentiment

Conversely, risk-on sentiment emerges when investors are more confident about economic prospects, leading them to seek higher returns in equities and riskier assets. This is often fueled by positive economic data, accommodative central bank policies, or geopolitical stability. Should upcoming U.S. CPI data and Fed Chair Powell's testimony provide reassuring signals about inflation control and economic growth, markets might shift towards a risk-on stance, boosting equity markets and high-yielding currencies.

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