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It's been a rotten week for the dollar, with Janet Yellen's acknowledgement on Wednesday that there are concerns within the Federal Reserve about persistent low inflation hitting the currency quite hard as traders revised lower their expectations for another rate hike this year. This comes at a time when traders were already doubting whether the Fed would follow through on plans for a third hike.

The data from the US has been relatively uninspiring, particularly on the inflation side and the numbers today will have done nothing to give policy makers any more confidence. While CPI may not be the Fed's preferred measure of inflation, it is released three weeks before the core PCE price index and therefore offers plenty of value. The PCE price index may be a little lower than its CPI alternative but they tend to follow similar trends and today's drop in headline CPI doesn't bode well for it.

The consumer figures were no better, with retail sales falling for a second month and continuing a worrying trend this year. What's more, the UoM consumer sentiment survey indicated that things are not going to improve, with current conditions actually exceeding forecasts but expectations falling far short, dragging the overall reading much lower.

As is to be expected, the US dollar has not fared well since the data was released and is currently down around half a percent on the day with sterling trading at a near 10 month high against it and a number of other currencies testing similar levels. Even the yen, which has struggled in recent months, is performing well against the greenback although as it stands, there's little reason to believe this is anything more than a correction.

GBPAUD has recorded a downtrend since last peaking at a nine-month high of 1.7650 on May 10. However, the pair is currently finding difficult to reach above 1.70 handle as the short-term bias remains bearish, while medium-term outlook continues to be neutral.

In the near-term, technical indicators do not point to any disruption of the current bearish bias pattern. Instead, there is more risk to the downside, as prices have crossed below the Ichimoku cloud, as well as the 50-day and 200-day exponential moving averages (EMA), while if prices fall below the previous low of 1.6611, an extension of the current downtrend might occur. Moreover, the RSI and the MACD give an additional bearish signal, fluctuating below their thresholds. The RSI has been trending down under 50 since July 10, whereas the MACD despite pushing higher on June 30, has flattened out in negative territory.

Should the pair build on the downside momentum, it would find support first at the previous low of 1.6611 and then at 1.6570, which is the 61.8% Fibonacci level of the March-May upleg from 1.5902 to 1.7650. Further declines, would touch the 78.6% Fibonacci of 1.6257.

Alternatively, resistance is expected at the 50% Fibonacci mark of 1.6775, while a stronger barrier to upside movements is likely to be found around the 38.2% Fibonacci of 1.6980, between the two EMAs and within the Ichimoku cloud. The latest top of 1.7121, could also act as a potential resistance.

Looking at the medium-term picture, the market maintains neutral as long as it ranges between 1.7800 and 1.5742.

The dollar tumbled against all majors after a set of disappointing US data releases. The dollar index fell to a fresh 10-month low of 95.25 immediately following the release. The weaker dollar boosted other majors as well as gold.

Both US CPI and retail sales numbers for June came in short of expectations, pushing the dollar to 112.38 yen from 113.04.

Headline CPI was weaker than estimated at 0.1% month-on-month in June, mirroring the prior increase of 0.1%. It was expected to increase by 0.2%. Meanwhile, year-on-year, CPI rose 1.6% versus a prior 1.9% and below the expected 1.7%. Core inflation maintained the momentum with a 1.7% year-on-year increase, as forecasted.

The US retail sales data ex-autos showed a 0.2% month-on-month decline in June, well below the expected 0.2% gain, but an improvement from the prior 0.3% fall. Total retail sales were also down by the same amount and the control group (ex-auto, gasoline, food service and building materials) declined 0.1%. There were some minor upward revisions to May's total figure but not enough to offset the shortfall in June.

Today's weak data along with the earlier dovish-perceived take on US monetary policy by Federal Reserve Chair Janet Yellen, confirms markets skepticism of another rate hike this year.

The dollar was additionally pressured by a report showing US consumer sentiment worsened in July. The preliminary University of Michigan index fell to 93.1 from June's final reading of 95.1 and came in below the forecast of a 95.0 reading.

Aside from US data, investors also had their focus on Federal Reserve Bank of Dallas President Robert Kaplan (an FOMC voting member) who is scheduled to speak at a conference in Mexico today.

In the absence of notable economic data releases out of the UK and the eurozone, the US data release dictated most of the forex trading today. On the back of dollar weakness, the euro rose to $1.1451, while the pound breached above the 1.3000 level, hitting a two-month high. The Canadian dollar also gained with dollar/loonie dropping to 1.2682.

Oil prices continued gaining for the second consecutive day, rising by around 1% today. WTI and Brent got a boost in late European session following the news that Kuwait's OPEC governor Haitham Al-Ghais said in an interview to Reuters that the market was on a recovery track due to increasing global demand.

Inversely related to the dollar, gold prices rose as the dollar plunged in early US trading hours. The precious metal was last trading just above $1,230.00 an ounce.

As financial market focus intensifies over the price environment, CPI inflation came in below consensus expectations in June, reinforcing the Fed's interest as they evaluate future monetary policy tightening action.

Another Soft Month

On balance, consumer inflation has registered soft performances over the prior four months and June was no exception as headline Consumer Price Index (CPI) was unchanged. The flat monthly performance was lower than the consensus expectation, and reinforces the view that the price environment exhibits little upward momentum as we enter the second half of the year. Year-over-year, headline CPI has steadily declined from its 2.7 percent recent high in February to its current reading of 1.6 percent.

Looking at the two components that can heavily influence the headline, the energy index declined for the second straight month, -1.6 percent, as all three component indices fell. The food index was unchanged on the month, after registering gains over the previous five months.

Excluding food and energy, the core CPI rose 0.1 percent on the month, the third consecutive increase at that below trend pace. A perennial group of components accounted for the softer-than-expected gain with apparel declining for the fourth straight month, new & used cars falling for the sixth consecutive month, airfares contracting for the third straight month, and wireless services down for the fourth consecutive month. That said, some of the larger components of core CPI saw larger price gains, including rent and owners' equivalent rent both rising 0.3 percent and medical care services also advancing 0.3 percent on the month. The three month annualized rate of core CPI firmed to a 1.0 percent pace, but remains below the 1.7 percent year-over-year pace and, therefore, suggest there is little upward pressure on core consumer inflation as Q3 unfolds.

Inflation Performance Takes Pivotal Role to Future Rate Hikes

At this past week's monetary policy testimony before Congress, Chair Yellen reiterated the Fed's view that the "recent lower reading on inflation are partly the result of few unusual reductions in certain categories of prices." Today's report placed more pressure on that view as a broad base of components shows little sign of let up. That said, officials did cut their 2017 headline and core PCE deflator projections - their preferred measures of consumer inflation - in the June economic outlook (down to 1.6 percent and 1.7 percent year-over-year, respectively, for Q4). We too have recently lowered our consumer inflation projections, taking headline and core CPI down to 1.8 percent and 1.9 percent year-over-year, respectively, in Q4 (we also cut our headline and core PCE deflator projections to 1.6 percent yearover- year each in Q4). Our updated forecasts generally agrees with Fed officials' sentiment that recent weakness should not be extrapolated into the second half of the year, but that any gains are also likely to be limited. There is a lot of runway left before the December FOMC meeting where we believe the Fed may be in position to hike interest rates again, but a return to a quickening pace of inflation is critical to that call.

Retail sales came in lower than market expectations, down 0.2 percent in June, while the 0.3 percent decline in May was upwardly revised to a decline of 0.1 percent. Once again gasoline sales were down in the month.

Weakness in Retail Sales Persists

American consumers continued to disagree with themselves in June as consumer confidence has remained high but has still not translated into much higher consumption. Once again, nominal retail sales dropped in June, this time by 0.2 percent, driven by a 1.3 percent decline in gasoline sales, the fourth consecutive monthly decline for this sector of retail as gasoline prices continued to come down. However, gasoline sales were not the only culprit for the weakness. Food and beverage consumption declined 0.4 percent while clothing sales did so by 0.1 percent. Sporting goods sales were down 0.6 percent and remained the worst performing sector on a year-over-year basis, down 7.7 percent, non-seasonally adjusted.

Although general merchandise sales increased 0.4 percent during the month and are up 2.3 percent on a year-earlier basis, department stores sales were down once again, this time by 0.7 percent, and were the second worst performing sector on a year-earlier basis, down 4.2 percent. Meanwhile, miscellaneous store retail sales slumped 3.1 during the month after declining 0.7 percent in May. Miscellaneous store retail sales were very weak, up 0.8 percent, on a year-earlier basis in June. The last weak sector was eating and drinking places sales, which represents the service side of the report. Those sales were down 0.6 percent in the month.

On the positive side, motor vehicles and parts sales were up a third consecutive month, increasing 0.1 percent, and reversing the strong weakness shown during the first quarter of the year. On a year-earlier basis, motor vehicle sales were up 4.3 percent. Meanwhile, furniture sales and electronics sales were up 0.1 percent month on month while they were up 3.5 percent and 1.6 percent on a year-earlier basis.

Building materials sales were up 0.5 percent in June after declining 0.6 percent in May while health and personal care sales improved 0.3 percent. Perhaps the only sector that continues to beat the trend, not surprisingly, is non-store retailer sales, which increased 0.4 percent after doing so by 0.8 percent in May. This sector continues to be the strongest sector of retail, growing at a 9.9 percent on a year-earlier basis.

Overall a Disappointing Performance for Retail Sales

Although personal consumption expenditures are expected to bounce back during the second quarter of the year, the bounce back may not be as strong as what we were expecting if these numbers remain as they were originally published, which is a big if. Furthermore, this is a nominal report, meaning that the real numbers may do the trick to help consumer demand growth in the second quarter. However, that is no help for retailers looking for higher revenues on their sales efforts.

USD is falling after bad US CPI and Retail sales data. We see EURUSD turning up sharply following a break above the upper channel line which suggests that pair accomplished a three wave set-back and that market is underway to a new high. There is room for 1.1500, or even 1.1550.

• European equities traded sideways in a tiny range during European trading hours, but start losing ground in the US session. US stock markets opened marginally higher, unnerved by lacklustre earnings from several financial institutions.
• US consumer prices were unchanged in June as the cost of gasoline and mobile phone services declined further, pointing to benign inflation (1.6% Y/Y) that could cast doubts on the Federal Reserve's ability to increase interest rates for a third time this year.
• US retail sales unexpectedly fell in June (-0.2% M/M) for a second straight month, which could temper expectations of strong acceleration in economic growth in the second quarter. US industrial production rose by 0.4% M/M in June, slightly beating consensus (0.3% M/M).
• The EMU's trade in goods surplus inched up in May as import and export values both grew on the back of another bumper performance in Germany. Official trade figures from Eurostat show the bloc's seasonally adjusted surplus in goods rose 2.1% from €18.6bn to €19.7bn in May. The reading was just below an average forecast of €20bn.
• The European Central Bank is keen to keep its asset purchases open-ended rather than setting a potentially distant date on which bond-buying will stop, to retain flexibility in case the outlook sours, three sources familiar with the discussion said.
• JP Morgan's equity and fixed income trading revenues were at the low end of already low estimates, while investment banking fared better than expected. Its shares fell 1.4% pre-market. Citigroup posted a healthy beat on EPS but whiffed on equities trading. Its stock was little changed while Wells Fargo fell 1.3% after its earnings.

Rates

Core bonds profit from disappointing US eco data

Global core bonds traded with a minor upward bias in the run-up to key US eco data. The European eco calendar was empty and equity/commodity markets didn't provide input from a risk sentiment point of view. The first, and most important, batch of US eco figures disappointed. Both headline US CPI and US retail sales failed to beat (rather low) consensus. Core bonds profited with US Treasuries outperforming German Bunds. Fed chair Yellen's subtle warning on subdued inflation echoed in investors' minds. The downside in US Treasuries now seems protected in the run-up to the July 26 FOMC meeting and with potential US political upheaval in mind (Russian investigation; health care bill). US industrial production rose marginally more than forecast (0.4% M/M), but couldn't turn the tide going into the weekend.

At the time of writing, the US yield curve drops 2.8 bps (2-yr) to 5.3 bps (5-yr) lower. The belly of the US curve outperforms the wings. The German yield curve bull flattens with yields 0.9 bps (2-yr) to 3.5 bps (30-yr) lower. On intra-EMU bond markets, 10-yr yield spread changes versus Germany range between -2 bps and +2 bps with Italy (-5 bps), Spain (-6 bps) and Portugal (-6 bps) outperforming.

Currencies

USD suffers after data, but no EUR/USD topside break

Markets counted down to the US CPI and retail sales today. The US CPI was marginally softer than expected, but the retail sales showed quite a substantial miss. US yields and the dollar declined, but the damage could have been worse. Especially the rise of EUR/USD remains modest. The pair trades currently in the 1.1450 area. USD/JPY is hit hard (currently 112.40 area).

Overnight, Asian equities traded mixed, awaiting key US data later today. USD/JPY regained the 113 mark as markets expect the BOJ to maintain its cap on the 10-year government bond yield even as rates in other major economies are trending higher. However, the USD/JPY rise had no strong momentum. EUR/USD remained in wait-and-see modus, holding in the low 1.14 area

There were no important data in EMU. During the morning session, trading in European equities, bonds and in the major FX cross rates was confined to very tight ranges as investors didn't want to add positions ahead of the key US CPI and retail sales data. EUR/USD settled just north of 1.14. USD/JPY hovered in the low 113 area.

US headline inflation was marginally softer than expected (1.6% Y/Y). The miss in the June retail sales was more substantial (-0.2% M/M vs 0.1% M/M expected). The combination of soft inflation and disappointing retail sales pushed US yields up to 5 bps lower. However, given the recent focus on inflation, the damage could have been worse. The dollar also ceded ground. Especially, USD/JPY was hit hard. The pair dropped from the 113+ area to fill bid in the 112.27 area. The loss of the dollar against the euro was more modest. The pair jumped higher in the 1.14 big figure, but a real test of the 1.1489 top didn't occur (yet). The US production data released later in the session were slightly stronger than expected. As usual, the impact was limited. At best, they slowed the decline of the dollar. EUR/USD trades in the 1.1460 area, but trading remains volatile. EUR/JPY is changing hands in the 1.1460/65 area.

No UK specific news to guide sterling trading

There was hardly any UK specific news to guide sterling trading today. There were plenty of press articles on the UK accepting the principle of a financial settlement, but the debate had no impact on sterling trading. EUR/GBP held an extremely tight sideways range around the 0.88 pivot. EUR/GBP hardly profited from the post-US-CPI rebound of EUR/USD which can be seen as a tentative sign of underlying sterling strength. Cable rebounded north of 1.30 on the overall decline of the dollar.

Highlights:

• The all items index was unchanged month-over-month in June but the year-over-year rate of inflation slipped to 1.6% from 1.9% in May.
• Just less than one third of CPI categories were growing at 2% year-over-year in June.
• Energy prices fell for the fourth time in five months. Gasoline prices, which have been a major factor in those declines, are now little changed relative to a year ago.
• Food prices were flat in June but up from year-ago levels as the disinflationary impact from that component continues to wane.
• Consumer prices excluding food and energy rose by just 0.1% for a third consecutive month. The year-over-year rate of core inflation was unchanged at a two-year low of 1.7%.
• Wireless phone services prices were down 13% year-over-year, exerting a 0.2 percentage point drag on headline inflation.

Our Take:

After three months of inflation readings falling well short of expectations, today's report was a bit closer to consensus with the headline index coming in just 0.1 percentage point below expectations while the core inflation rate was unchanged as anticipated. It's not much, but that should come as some relief to the Fed. They have attributed some of the recent slowing to transitory factors, but further disappointment would make that position more difficult to defend. In testimony to Congress earlier this week, Chair Yellen once again expressed confidence that increased resource utilization will ultimately put upward pressure on prices. But with concerns that the link between economic slack and inflation has weakened, we think the Fed will want to see some evidence of rising prices as they continue to scale back stimulus. We look for the Fed to announce plans to begin shrinking their balance sheet in September, holding off on a rate hike at that time to gauge the market impact of tapering. That brief pause should give policymakers some time reassess the trend in inflation ahead of what we expect will be another rate increase in December.

The headline consumer price index (CPI) was unchanged (0.0% m/m) in June, weaker than the 0.1% increase markets were expecting. A 1.6% drop in energy prices on the month and flat food prices offset a 0.1% increase in core prices. Inflation on a year-on-year basis continued to cool, and now sits at 1.6%, the lowest reading since last October.

Given the loss of headline inflationary momentum in recent months, all eyes were on core inflation where a modest 0.1% increase brought the streak of soft readings to the fourth straight month. Core inflation was 1.7% year-on-year in June, matching the previous months' pace.

Within the core, services inflation posted a moderate 0.2% m/m increase, supported by higher prices for shelter (+0.2% m/m). Prices for medical care (+0.4%), motor vehicle insurance (+1.0%), education(+0.3%) and personal care (+0.3%) all increased. These gains were partly offset by lower prices for airline fares (-2.7%), both new (-0.3%) and used (-0.7%) vehicles, and wireless telephone services (-0.8%).

Overall the tug of war in core inflation between falling goods prices (-0.1%) and rising services prices (+0.2%) continued in June. That dynamic has been in place since 2014, exacerbated by a strong U.S. dollar. Now, the services side of the rope is losing some strength. Core services inflation was 2.5% y/y in June, a notable cooling from the 3.2% pace in Q3 2016. Meanwhile core goods prices are in deflationary territory, down 0.6% from a year ago, a pace that has been reasonably steady over the past year.

Key Implications

Well, it could have been worse. Bond yields are lower on the disappointment in June inflation, but we take some solace from the fact that prices for core services continued to post moderate 0.2% monthly increases, deflation in core goods let up slightly in June and some areas of idiosyncratic price declines have reversed. Moreover, the deflationary impact of a stronger U.S. dollar over the past two and a half years is expected to ebb in the coming months given the dollar performance as of late.

Earlier this week, Fed Chair Janet Yellen emphasized the idiosyncratic nature of the recent loss of momentum in core inflation. While one-off price drops in specific categories are part of the story, it doesn't explain the entire weakening in inflation seen in measures of inflation that strip out such volatility (trimmed mean or median CPI). Inflation has weakened across many advanced economies, suggesting that a broader phenomenon – such as persistent economic slack globally – may be playing a role.

Given an increasingly tight labor market, we expect inflation pressures to build through the remainder of the year, but the process is proving slower than expected. This adds considerable risk to the pace of Fed hikes over the rest of this year and in 2018.

Retail sales fell 0.2% in June according to the advance Census Bureau report. This was well below expectations for a 0.1% gain, although it comes atop of an upward revision - May's sales were revised up to a decline of 0.1% from 0.3% reported previously.

Sales excluding autos also declined 0.2%, as receipts at motor vehicle & parts dealers (+0.1%) were largely flat in line with the lackluster performance in auto sales during the month. Gasoline station purchases fell 1.3% on lower prices, with sales excluding autos and gas down a more subdued 0.1%, but still below the flat reading expected by the street.

Excluding gas, autos, building materials (+0.5%), and food services (-0.6%), the so-called 'control group' used in calculating GDP, was down 0.1% on the month - also below the flat reading that was expected. Sales in the control group were dragged down by miscellaneous (-3.1%), department stores (-0.7%) and sporting goods (-0.6%). These were more than offset by gains in non-store and e-commerce retailers (+0.4%), general merchandise (+0.4%), and health & personal care stores (+0.3%).

Key Implications

The weak retail sales print in June is without a doubt a disappointment as far as the resilience of the consumer is concerned. While the slight upward revision to May helps offset some of the bleakness in the June print and some of the weakness in the headline can be attributed to weak price backdrop (telegraphed in the CPI report released at the same time) leaving our second quarter GDP estimate largely unchanged near 3%, the story is less upbeat as far as momentum heading into the third quarter.

Given the weak handoff in the control group consumption appears to be decelerating closer to the 2% mark heading into the third quarter. Together with the relatively broad-based weakness in discretionary spending categories, it leaves us somewhat concerned and somewhat puzzled - particularly given the continued strength in the labor market in recent months.

The weakness is both the retail sales and CPI report is likely to be a key topic of discussion when the Fed meets at the end of the month. While we don't expect much to come from that meeting and still expect the Fed is to proceed with its normalization of the balance sheet come September, expecting an improvement in data flow in the coming months, another hike later this year seem less and less likely at this point.