Take-aways upfront: 

• The USD looks to…

The USD has fared fairly well so far this year with a strong US economy and hotter than expected inflation data, which reversed the downtrend from Q3/Q4 last year. There are however reasons to believe that the Fed will provide conditions for the USD to weaken further, especially if they keep their promises of cuts in 2024.

Yellen recently admitted that it was a mistake of her to believe that inflation was transitory, clearly a signal that US and Fed officials might have overestimated the disinflationary wave seen late last year, and the 1Y break-even rate have been allowed to climb 2 percentage points since the start of the year. 

While markets have hawked up rates expectations for both June and December, the idea that the Fed would even cut rates at all with inflation expectations on the rise leaves an interesting outlook for both the USD and US rates, as the Fed will possibly allow for real rates to diminish even further (also compared to peers). 

The combination of inflation expectations rising while markets are still pricing in cuts gives room to the idea that markets are expecting the Fed to abandon the 2% target and accept 3-3.5% in 2024 / early 2024 while cutting rates. The FOMC meeting next week will provide more details on this, and it will likely give the Fed an opportunity to hawk up their dot plot, which will however still show cuts planned for 2024 (just postponed).

Chart 1.a: US Inflation Expectations on the rise