The FX market is abuzz with the latest developments in the dollar's performance, with a particular focus on the retreat of the dollar debasement trade. This trade, which had been supported by the assumption that the Federal Reserve would remain captured by the White House, is now facing a significant challenge as US real interest rates rise, forcing an unwind of last year's debasement trade. The market's anticipation of the Fed's response to this year's inflation shock has led to a 60 basis point increase in US real rates over the last six weeks, putting pressure on popular debasement trade targets such as gold, bitcoin, and the Swiss franc. The dollar's recovery, driven by the expectation of Fed action, is a key theme in the market's current dynamics. The upcoming US May CPI release is expected to show headline inflation rising above 4.0% year-over-year for the first time since May 2023, with core CPI also expected to rise. This could further support the dollar's bid position, as the market continues to price in a Fed hike in December. However, a slight wrinkle for dollar bulls could be the core CPI release, as any signs of a loss of disposable income impacting consumer spending could rein in hawkish Fed tightening scenarios. The market's attention is also on the US real interest rates, which have risen 60 basis points over the last six weeks, putting pressure on the debasement trade. The flow of $99 billion into USD-denominated money market funds last week is a notable development, indicating a continued interest in the dollar. With upside risks to energy prices, the DXY is expected to remain bid on dips, and any soft core CPI reading could see the DXY test the 99.50/60 area. The euro, on the other hand, is consolidating into the European Central Bank, with a slight upside risk if the ECB fails to rule out a hike at the July meeting. The Norwegian krone has been a beneficiary of the energy crisis, and the Canadian dollar is expected to remain a laggard in the G10 space, with the Bank of Canada leaning dovish today. The Czech koruna is also painting a bullish picture for the FX market, with the Czech National Bank expected to hike rates at the June meeting. The market's focus on these developments highlights the dynamic and evolving nature of the FX market, with a continued emphasis on interest rates and inflation.
