Currency Market Responds Lukewarmly to US Inflation Report, Dollar Weakens

The currency market showed a relatively subdued reaction to the US inflation report for August, which nevertheless indicated that monthly core inflation was higher than expected at 0.3% (forecasted 0.2%). The dollar index, after a brief upward movement, began to decline. The Treasuries market also did not perceive hawkish risks in the report, prompting investors to engage in fairly confident buying of Treasury bonds following the news:Headline inflation accelerated from 3.2% to 3.7% on an annual basis (forecasted 3.6%), while core inflation remained unchanged compared to the previous month, standing at 4.3%. A closer look at the report reveals several factors explaining why the market wasn't surprised by the uptick in monthly core inflation:One of the most crucial components of the report, heavily monitored by markets and the Fed, inflation in the services sector, remained unchanged compared to the previous month, at 0.4%. Furthermore, the sub-component that tends to be the most “sticky”, shelter inflation, decreased to 0.3% compared to the previous month's 0.4%. It's worth recalling that the Federal Reserve pays special attention to service sector inflation as it is the least responsive CPI component to changes in monetary policy, and the success of the Fed’s policies is often measured by its dynamics. As for shelter inflation, it is one of the most inert and low-volatility components, accounting for a significant weight (over 30%) in the index. Perhaps for these reasons, the market perceived US inflation trend risks more as skewed to the downside rather than upside, leading to a shift in trading towards selling greenback and buying bonds. The absence of significant inflation surprises on the upside will likely allow market participants to gradually build short positions in the USD, as the search for yield is expected to gain momentum (to which dollar is inversely correlated). The short-term target for the dollar index is the lower boundary of the current ascending channel, corresponding to the level of 104: