US dollar bulls are back in town

• US dollar bulls are moving in following a significant sell-off in the greenback. 
• US yields perked up towards the end of the week as hawkish Fed sentiment overrides softer US inflation data.

The US dollar, DXY, was set for its third weekly loss in four against its rivals, but the bulls are moving in on the final day of the week in a turnaround in US yields and mix sentiment surroufing the outlook for the Federal Reserve. At the time of writing, DXY is trading at 105.2810, up 0.18% on the day so far. 

Benchmark US 10-year Treasury yields were oscillating near a three-week peak, recovering on Thursday as San Francisco Federal Reserve Bank President Mary Daly said a 50-basis-point interest rate hike in September "makes sense" given the recent economic data including inflation. Crucially, she also said that she is still open to a bigger rate hike if data warrants.

Earlier this week, US Fed policymakers noted that they would continue to tighten monetary policy until price pressures were fully broken. Following yesterday's CPI, Neel Kashkari unleashed his inner hawk and said the July CPI data did not change his expected rate path, though he was happy to see inflation surprise to the downside. Kashkari stressed that the Fed is far from declaring victory over inflation and stressed that recession “will not deter me” from getting to the 2% target. 

Fed funds futures traders are now pricing in a 61.5% chance of a 50-basis-point hike in September and a 38.5% chance of a 75-basis-point increase. Analysts at Brown Brothers Harriman explained that WIRP is now showing only 45% odds of a 75 bp hike at the September 20-21 FOMC meeting vs. 80% before the CPI data.

''Looking ahead, the swaps market is now pricing in a 3.5% terminal rate vs. 3.75% at the start of this week.  We think the markets are once again overreacting to one data point. The battle to lower inflation is likely to be long and protracted, with most Fed policymakers looking at an extended tightening cycle. Yes, we may have seen the worst in terms of inflation, but we are a long way from the Fed’s 2% target.  Markets should also reprice the more dovish expectations in the coming days and weeks.''

Meanwhile, analysts at TD Securities argued that ''a potential inflation peak (and associated end to Fed terminal rate price discovery) is an important ingredient to call the top in the USD.''

''The other key (and arguably) more important ingredient is the outlook for global growth. On that factor, we don't think it is time to completely fade the USD, though the recent backdrop reductions convictions on USD long exposure,'' the analysts explained.