Overnight Headlines

*USD was mixed in a choppy session but is edging higher

*US equities closed lower, Asian markets are gaining

*Bond yields declined, with the US 10-year Treasury falling below 1.5%

US equities fell modestly yesterday as growth beat value due to the relatively dramatic move in bond markets. Falling US yields, which fell to their lowest in a month, saw rotation within equities to growth stocks out of value as high growth tech companies are most sensitive to interest rate expectations. European markets are set to open in the green, following Asian markets higher.

USD dropped below 89.90 before rallying hard around the US open. GBP has traded moderately softer alongside commodity currencies but moves have been subdued this week in anticipation of today’s risk events. USD/CAD edged higher above 1.21 as the BoC left policy unchanged but did offer hints that we should expect more tapering soon.

Market Thoughts – US CPI is finally here

The US CPI numbers for May are released as the same time as the ECB press conference starts, this afternoon at 12.30 GMT. The focus for the former is on the % m/m changes with analysts expecting some moderation in both the headline and core numbers to 0.5% compared with April’s 0.8% print. The y/y number is forecast at 4.7% from the prior 4.2% in April which would be the largest increase since September 2008.

Base effects are the primary reason for the surge which are set to level off in June. Economists says we should be watching used car prices and the rent of shelter component in the core inflation report. This may give us a heads-up about whether we can look through the current jump in prices or they are more long-lasting, which would contrast with the Fed’s current “transitory” view. Bond markets have turned already with yields on a steady decline all week. It would seem that an upside surprise ( > 4.9% y/y) is needed to reverse these moves. For FX, USD/JPY may get a boost from a big number but gains may be limited ahead of next week’s FOMC meeting.

Chart of the Day – ECB and taper talk

The other main event of the day is the ECB meeting which is expected to raise its growth forecasts for this year and next year. All eyes will be on the wording for its emergency QE (PEPP) purchase guidance with some hoping for a potential shift from “significantly” to “moderately” higher than at the start of the year. This change would see buying reduced to €70billion/month in Q3 versus the current purchase rate of €80billion/month.

However, consensus is for no change in bond buying guidance so risks are skewed to a modestly higher EUR if President Lagarde does not repeat the “taper on hold” message explicitly during the press conference. The dovish bar is high but if we do hear outright caution, EUR/USD could sink towards last Friday’s low and the 61.8% Fib level around 1.21 in disappointment. The euro has generally been holding its uptrend since late March, but buyers have struggled keeping gains above 1.22. The end of May high at 1.2266 is the target (with a Fib level before this at 1.2211) if Lagarde is more bullish and confidence in the recovery is so strong that the ECB set the stage for QE reductions.