The US dollar holds its own near yearly highs ahead of release of US inflation report for July. According to consensus, core and broad inflation should finally start to ease after gaining 0.9% in June. However, recent inflation forecasts have been underestimating actual price growth and this month can be no exception. Any inflation surprise on the side of acceleration will make more compelling the case where the Fed moves earlier to tapering of bond purchases this year and moves on to policy tightening next year. Consequently, the risks for USD are skewed towards extension of the current rally after release of the report, however, markets apparently started to price in a hawkish surprise since the end of last week. For the last four trading days, the dollar has been making successive higher highs indicating mounting bullish pressure ahead of the news:

The Treasury market also appears to be worried about inflation outlook, especially the far end of the yield curve. The yield on the 10-year Treasuries is rising for the sixth day in a row, upcoming approval of the infrastructure spending package in the United States, which will also be financed through long-term borrowings, also contributes to the bonds sell-off:

If the inflation report points to acceleration in price growth, the Fed may have to raise rates faster than is now expected. Fed funds futures priced in first rate hike in December 2022, however the market doesn’t expect the rate to exceed 1% over the next 3 years which can be altered by today’s report.

Used car and fuel prices have contributed greatly to the rise in US inflation in recent months. If price pressures in these markets persist, it is likely that inflation could overshoot forecast again. With the continued recovery in mobility in the US and strong growth in consumer spending, demand for cars was likely to remain strong in July, so this component could lead to strong consumer price increases again. However, the Fed is unlikely to consider this a sustainable phenomenon. The net effect for the dollar may turn out to be negative in the short term, however, closer to Jackson Hole, the rally of the American currency is likely to resume.