Modest US Payrolls Spur Dollar Sell-Off but CPI may Come to the Rescue

Until the NFP release last Friday, the US fundamental backdrop was quite favorable for the dollar and equities. ADP reported around 500,000 new jobs, and the ISM services activity index comfortably exceeded expectations. The dollar index even managed to touch a three-week high at 103.50, while the S&P 500 remained near 4450 points.However, the official unemployment report interrupted the streak of positive data surprises. Job growth fell short of even the modest forecast of 225K, coming in at 209K. Wage growth, which increased by 0.4% on a monthly basis, provided a slight positive note.Judging by the reaction of short-term bonds and the dollar, investors clearly expected something more impressive. The dollar entered into almost disorderly retreat, declining by 0.7% by the end of Friday. The yield on short-term two-year bonds dropped by 10 basis points to 4.9%, reflecting reduced chances of two rate hikes by the Federal Reserve (Fed) by the end of the year. On Monday, demand for Treasuries continues to exceed supply at all maturities, but market participants are cautious as the US CPI release for June is ahead.The dollar index continues to form a weak ascending channel. The buyers' target may be the upper boundary of the short-term bullish channel intersecting with a long-term resistance trendline (at the 104 level), while the sellers' target likely resides at the horizontal support level of 101:The S&P 500 opened with a downward gap on Friday, attempted to rally but failed to sustain the gains. The closing level ended up below the psychologically important 4400 points. The unemployment report was clearly unimpressive, and if the CPI on Wednesday does not surprise with a fall below 0.3% MoM, a correction is likely to gain force. The nearest targets are the 200-hour SMA at 4330 and the 50-day SMA at 4250 points. Additionally, the price being near the upper boundary of the medium-term channel eases the downward movement:Despite Fed efforts to convince the market of the need for two more rate hikes this year (totaling 50 basis points), investors continue to view the second hike skeptically, considering that derivatives' pricing reflects only 35 bps of tightening before the rate reaches its peak in this cycle. If consumer inflation continues to resist, the markets will have no choice but to align their expectations with the Fed's forecasts. In this scenario, the dollar should resume a significant strengthening against major currency counterparts as well as emerging market currencies, and Treasury yields would reach new local highs.