The US dollar held firm as Brown Brothers Harriman linked recent US data to stalled disinflation and price pressures that remain sticky relative to the Federal Reserve’s 2% target. The note pointed to improving US labour demand alongside a more restrictive Fed policy stance, with the currency seen edging higher as markets refocus on incoming inflation pipeline indicators.
May CPI data were cited as evidence that the disinflation trend has lost momentum: headline inflation rose to 4.2% y/y from 3.8%, marking the highest reading since April 2023, while core CPI ticked up to 2.9% y/y from 2.8%. On a monthly basis, core CPI increased 0.2% m/m versus 0.4% previously, coming in 0.1ppt below expectations. Attention now turns to May PPI due at 1:30pm London time (8:30am New York), with focus on PPI Services less Trade, Transportation, and Warehousing and its link to core services less housing PCE, alongside measures such as core services less housing CPI, Atlanta Fed sticky CPI, and Cleveland Fed trimmed mean and median CPI.
US Dollar Momentum and Trading Strategies
Given that the US Dollar is firm, we expect it to edge higher in the coming weeks. The recent May Consumer Price Index (CPI) report showed inflation accelerating to 4.2%, and key underlying measures are moving further from the Federal Reserve’s 2% goal. This supports strategies like buying call options on the US Dollar Index (DXY) or selling puts on currency pairs like the EUR/USD.
A strong labor market reinforces this view, as the May jobs report showed a robust addition of 245,000 jobs, beating expectations. For derivative traders, this signals a more restrictive Fed policy, and we are now pricing out significant rate cuts for the remainder of the year. Interest rate futures now show only a 15% probability of a rate cut by the September meeting, down from over 50% just a month ago.
Fed Policy Outlook and Equity Market Implications
This combination of a hawkish Fed and a strong dollar typically creates headwinds for equities. We believe traders should consider defensive positions, such as buying put options on the S&P 500 to hedge against potential downside risk. An increase in VIX call option volume also suggests the market is beginning to anticipate higher volatility around upcoming economic data releases.
This environment is reminiscent of the 2022-2023 period when persistent inflation forced the Fed to remain aggressive, causing significant dollar strength. Back then, markets consistently underestimated the Fed’s resolve to keep rates high until inflation was clearly contained. We see a similar dynamic emerging now, which could present opportunities in rate-sensitive instruments.
