Summary:

The euro dipped below parity against the US dollar for the first time since December 2002 on Wednesday, although rebounded sharply during a choppy afternoon trading session.
The June US inflation print beat expectations (headline CPI rose by 9.2% vs. 8.8% expected, core at 5.9% vs. 5.7% expected). US Dollar Index briefly rose to a fresh 20-year high in response.
Futures markets priced in more than 150 basis points of rate hikes from Fed at next two meetings.
Bank of Canada surprises market with 100 bp rate increase (75bp move expected).

While there was a bit of confusion among market participants as to whether the parity milestone had actually been achieved on Tuesday, there was no doubt on Wednesday. The key pair has met significant support around the 1.0000 level in the past couple of days, with a wall of options preventing an easy move below the key physiological level. We mentioned yesterday that a bearish euro catalyst may be required to breach parity, which is exactly what we got from Wednesday’s US inflation report. US inflation increased by 9.2% in June (1.3% month-on-month), comfortably above the 8.8% expected by economists. Core inflation eased on a month previous, although also beat expectations, coming in at 5.9% (5.7% consensus).

Figure 1: EUR/USD (08/07/2022 – 13/07/2022)

Markets initially reacted to the US inflation surprise by piling into the dollar, as futures markets began pricing in 75 basis point hikes from the FOMC at each of its next two monetary policy meetings. We had contested there was a good chance the Fed could revert back to a 50bp hike when it meets later this month, but this now looks unlikely following yesterday’s data.

The move higher in the greenback was, however, rather short-lived, and EUR/USD moved back above the 1.01 handle as the afternoon progressed. Attention quickly turned to the impact of the inflation overshoot on the US economy, with market’s fretting that persistently high price growth, and an aggressive response from the FOMC, could tip the US economy into a technical recession later in the year. While we still argue that these concerns are slightly overdone, this risk has clearly heightened following yesterday’s data.

Indeed, it is now not out of the question that some Fed members could follow in the footsteps of their Canadian counterparts in supporting an even larger 100 basis points hike at the next FOMC meeting. The Bank of Canada shocked investors by raising rates a full one percentage point on Wednesday, their largest rate increase since 1998, while indicating that more hikes to above 3% in the base rate were on the way. In its press conference, the BoC said “by front-loading interest rate increases now, we are trying to avoid the need for even higher interest rates down the road’. Somewhat surprisingly, the reaction in CAD was relatively contained.

US producer inflation and initial jobless claims figures will be the main data releases today, although focus will be on whether EUR/USD has another go at breaching parity for the second straight day.

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