MUFG’s Lloyd Chan notes that softer US inflation in June has reduced upside risks to US yields, leading markets to unwind much of the July Federal Reserve hike pricing and scale back tightening expectations for 2026. However, elevated US real yields and safe-haven demand linked to Middle East geopolitical tensions continue to provide near-term support for the Dollar and keep one rate hike priced in.

Inflation surprise tempers Fed pricing

"US inflation surprised to the downside in June, with headline CPI easing to 3.5%yoy from 4.2%yoy and below the 3.8% market consensus, largely reflecting lower energy prices. Core CPI also softened more than expected to 2.6%yoy from 2.9%yoy, while monthly core inflation was flat. The softer inflation print prompted markets to largely unwind July hike pricing and scale back some expectations for Fed tightening this year."

"For FX markets, the key takeaway is that softer inflation has reduced upside risks to US yields, but has not fundamentally altered the high US real yield backdrop. The US dollar index (DXY) softened by 0.3%. USD/JPY ended 0.1% lower after recovering from an intraday decline of around 0.5% following the CPI data."

"Importantly, elevated US real yields continue to provide near-term support for the dollar, while rising geopolitical tensions in the Middle East are likely reinforcing safe-haven demand."

"But markets are still pricing in 1 Fed rate hike by year-end, while Fed Chair Kevin Warsh reiterated that the Fed would not tolerate high inflation."

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