OCBC strategists Sim Moh Siong and Christopher Wong note that softer United States (US) inflation data has reduced expectations of near-term Fed tightening, weighing on front-end US yields and the US Dollar (USD) while supporting risk-sensitive assets. However, higher Oil prices and Middle East tensions are capping Dollar downside. They still expect modest USD appreciation by year-end, with carry trades favored in the current environment.

Fed repricing and Oil risks

"A second consecutive downside inflation surprise in the US further reduced expectations of near-term Fed tightening, driving front-end Treasury yields lower and supporting risk-sensitive currencies. However, gains in longer-duration assets remained restrained as higher oil prices and geopolitical risks continued to weigh on sentiment."

"The case for a July Fed rate hike weakened further, with markets now pricing in just 2bps of tightening, down from 11bps on Monday. Softer-than-expected US PPI data, both headline and core, reinforced the disinflation narrative."

"The report also suggested that prices of certain electronic components used by US manufacturers stabilised in June, helping to ease concerns that the AI investment boom could generate broader inflation pressures."

"Even as US inflation proves more benign than initially feared, the follow-through from a weaker USD and lower US yields may be limited until there is greater clarity on energy-related supply risks."

"While we continue to expect modest USD appreciation by year-end, near-term upside momentum is likely to remain constrained in the absence of fresh catalysts. For now, this environment should remain supportive of carry trades."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)