The strong USD due to worries about US inflation surge and subsequent sell-off in equity markets is likely to be short-lived. The Fed’s “lower-for-longer” policy stance combined with rising inflation expectations should keep US real rates negative what will likely be an overriding factor in the USD supply-demand picture. However, firm signs that correction is over in equities is an essential condition for the USD downtrend to resume.

The uptick in US inflation above 4% in April notably increased risk aversion in equity markets. Comments of the Fed’s Vice Chair Richard Clarida magnified the bearish impact of the report, as he said that jobs and inflation data came as a surprise to him. This added to fears that the Fed may be starting to lose control over inflation stoking rumors that policymakers may start to tweak monetary policy earlier than expected. However, the irony is that inflation and labor developments require policy adjustments in opposite directions; high inflation could require policy tightening to tame it while the slack in labor market could be eased by adding or maintaining current levels of stimulus. Therefore, the market consensus on the Fed's policy will likely remain a continuing status quo.

However, there was a shift in interest rate futures - the likelihood of the Fed rate hike in December 2022 after the release of inflation report rose from 88% to 100%. We also saw considerable repricing in long-dated US government bonds - 10-year Treasury Note yield jumped from area of 1.6% to the vicinities of 1.70%, targeting this year's high at 1.77%.

Another Fed spokesman, Rafael Bostic, said yesterday that there is a lot of noise in the data and it will take at least 4-5 months to see the trend.

Despite the changes in odds of the Fed tightening events in 2022 and 2023, there are no expectations that the Fed will touch rates or alter QE volumes in the near future. We’ve got another confirmation of this idea from yesterday's speech of Richard Clarida, who attempted to dismiss potential impact of inflation report on the odds of policy tightening. Therefore, key USD drivers in the near future will likely remain a combination of negative real interest rates and rebound in the global economy, which should propel search for yield outside the US economy. In turn, this trend should be accompanied by mounting pressure on the US currency.

On EURUSD, the 1.20 defense looks quite solid and the upcoming data on the EU economy is likely to provide additional support, both in the main pairs and in the crosses. Growth prospects for EURUSD may be undermined by strong inflation data for April in the EU, however, we still do not know the reaction function of the ECB to strong inflation, so the euro holds nothing in this regard.

Strong data on the British economy, in particular, the GDP for March added arguments to buy the pound and the data for this quarter is likely to be even better. Against this backdrop, EURGBP may retest 0.85. Technically, a breakdown of the lower border of the current range (0.8590) may become a signal for this:

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