Inflation fears can spook markets. In the wake of a huge upside surprise on US CPI inflation earlier this week, there was a big sell-off on risk assets and the dollar rallied. However, this looks to be a near-term move and as the dust settles, the bigger picture trends are reasserting themselves once more. The dollar remains a sell into strength. This week’s volatility is simply another chance to jump back into the prevailing trends.

  • Bouts of volatility are likely to be a feature of market moves if data scares continue.

  • With bond yields stuck in a range, rising inflation is a drag on the dollar. 

  • EUR/USD and GBP/USD charts show weakness is a chance to buy.

  • However, currencies such as AUD & NZD are still ranging. 

Fears of inflation will mean occasional bouts of risk aversion

This week has proven that markets are pretty on edge when it comes to rising inflation. The big upside surprise saw a wave of panic across asset classes, with the dollar benefitting. But now, as bond yields are settling down within their ranges once more, a sense of calm is coming over once more. 

US Ten year Treasury yield

However, there are likely to be more bouts of fear-driven volatility in the weeks ahead. We are even on the lookout today as a clutch of major US data will be released this afternoon (Retail Sales, Industrial Production and Michigan Sentiment). Any significant upside surprises in the data could create more volatility.

However, we believe that any dollar strength would be a chance to sell once more. Unless bond yields can break sharply higher, we believe USD will continue to struggle. We expect Dollar Index to resume its path back towards the lows between 89.20/90.00.

Dollar Index

As “real” yields are falling, USD will struggle

So why is USD struggling even if Treasury yields are ranging? The reason is that inflation fears (and expectations) are rising. This is eroding the return that investors get from bonds, so by extension, USD suffers too. In real terms (adjusted for inflation), bond yields are falling. Whilst this continues, USD will struggle.

The correlation between the US 10 year yield and USD has broken down recently and moved to -0.37 (above zero is a positive correlation).

 Real yields are falling, USD will struggle

This has come as the correlation between “real yields” and USD remains strongly positive at +0.62, suggesting that inflation concerns are the key driver of USD.

21 Day Correlation

EUR/USD and GBP/USD are a buy into the weakness

Looking at the charts of major forex pairs, we see that the moves this week are giving opportunities.

The outlook for EUR/USD remains positive. Support is building further following the break above 1.2000 with the recent reaction low at 1.2050. Anything into this support band is a chance to buy for further upside pressure towards 1.2190/1.2240 and the multi-year high of 1.2350.


For GBP/USD the basis of support at the 1.4000 breakout is clear and was tested almost to the pip during Wednesday’s pullback. However, momentum remains strong and any weakness towards the 1.3950/1.4000 support band should be seen as a chance to buy for renewed pressure on 1.4165/1.4240.


However, commodity currency pairs are still ranging

It is interesting to see that the higher risk “commodity currencies” such as Aussie and Kiwi are not faring as well. They are very much still stuck in their ranges.

AUD/USD has been unable to break free and a false upside break above 0.7850 earlier in the week raises concerns for the outlook. Major markets are more jittery now and this means that the higher risk currencies may not fare so well. Aussie needs to hold on to support at 0.7675 otherwise the outlook turns more corrective.


NZD/USD is in a similar position. Hitting resistance between 0.7250/0.7305 leaves this as a key barrier now and momentum lacking intent. Support around 0.7115/0.7135 needs to hold.