USD: of USD cash (cows) and shooting stars

King USD continues to reign supreme over FX markets as the currency continues
to attract inflows from investors spooked by the worsening twin sell-off in the global
bond and stock markets. The sell-off has transformed USD cash into the ultimate
safe asset, further boosted by the rise of US real rates and yields on the back of
the Fed’s credible commitment to bring down inflation. That said, US rates
investors further think that most of the Fed tightening is behind us, expecting the
Fed funds rate to peak at 4.5% in March 2023. Underpinning the expectation is the
view that US core inflation will ease from its current lofty levels. Today’s core PCE
data could put the latter view to the test, with our US economist expecting the Fed’s
preferred inflation measure to re-accelerate in August to 4.8% YoY (consensus
4.7%) from 4.6% previously. If confirmed, the data will suggest that US core
inflation remains below the lofty levels from earlier this year but that it remains
stubbornly high and thus necessitates further aggressive Fed tightening. The
reaction in FX markets will be driven by the response of the US fixed income
markets as well as the resilience of the broad risk sentiment in the wake of the
data. To the extent that we do not see further aggressive front-loading of Fed hikes
and/or deterioration of risk sentiment, the USD may struggle to extend its recent
gains, with FX investors turning their attention to the upcoming US data next week,
ie, Non-farm payrolls and ISMs. In addition, it remains to be seen whether the
overbought and overvalued USD can receive a sustained boost from the monthend
rebalancing flows that are predicted by our model to be supportive for the

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