Asian currencies steady as US inflation data and less dovish Fed outlook keep dollar supported

Risk assets and Asian currencies steadied after Friday’s tech-led sell-off showed limited follow-through, while some Korean chipmakers rebounded overnight. Attention is shifting back to the cyclical FX theme of potential Federal Reserve tightening, following last week’s strong US labour market data. Near-term focus includes NFIB small business optimism, weekly ADP jobs figures and the April trade balance, alongside China’s latest trade release, which has lent support to the renminbi and the broader Asian currency complex.

In rates, Fed custody holdings data show a $71bn fall in foreign official US Treasury holdings since the start of May, a move linked to likely FX intervention across parts of Asia and its implications for Treasury sales. Macro risk pivots to US inflation prints, beginning with May CPI on Wednesday and PPI on Thursday, before a Federal Open Market Committee meeting in a week’s time that is expected to be less dovish. The US Dollar remains underpinned, with the US Dollar Index consolidating after a rally on Friday and support seen near 99.80 ahead of a potential retest higher later this week.

Key Market Drivers and Inflation Focus

While risk assets and Asian currencies appear to have found a temporary floor, we expect the US Dollar to remain well-supported on any dips. Markets are now in a holding pattern ahead of crucial US inflation data and the upcoming Federal Reserve meeting. This creates a clear focus for our strategy in the coming weeks.

Last week’s strong labor market report, which saw the May Non-Farm Payrolls add a robust 250,000 jobs, has shifted all attention to inflation this week. The upcoming Consumer Price Index (CPI) and Producer Price Index (PPI) releases are the market’s main focus now. We are positioned for firm data that could reinforce the Fed’s cautious stance.

Given that the latest CPI reading showed inflation holding stubbornly above the Fed’s target at 3.5%, we anticipate a far less dovish tone from the Federal Open Market Committee (FOMC) next week. This reduces the probability of any near-term interest rate cuts, which is currently priced at less than 20% for the July meeting according to market data. The “higher for longer” narrative is regaining strength.

Dollar Outlook and Implications for Traders

For derivative traders, this suggests that the US Dollar Index (DXY) will likely find solid support near the 104.00 level before attempting to retest its recent highs. We see opportunities in buying short-dated call options on the dollar against currencies with more dovish central banks. This is also a good time to consider hedging against any further dollar strength in portfolios.

The recent volatility in tech stocks appears to be a distraction from the primary macroeconomic story driving foreign exchange markets. Furthermore, we are watching the continued selling of US Treasuries by foreign central banks, with recent data showing a consistent decline in custody holdings. This trend could independently apply upward pressure on US yields and, by extension, the dollar.