US two-year yield fell 8 bp after soft CPI, but Middle East escalation and tech sell-off revived safe-haven bids. ECB meeting, UK political transition, and US data in focus this week.
The dollar ended last week with a split personality. It fell against most G10 peers after softer US CPI and PPI prints sent the two-year yield down nearly eight basis points. A renewed escalation in the Middle East and a sharp sell-off in equities, especially in AI and tech, gave the greenback a safe-haven bid that trimmed those losses. That tug-of-war between falling US rate expectations and geopolitical risk is set to carry into the coming days, with the ECB meeting, UK political transition, and US data on the calendar.
The US two-year yield dropped after both inflation gauges came in below consensus. The dollar index, which peaked near 101.80 on June 24, slid to 100.35 by mid-week before bouncing. The 30-day correlation between changes in the dollar index and the two-year yield stands near 0.60, while the correlation with the December Fed funds futures contract is closer to -0.70. After the Fed's hawkish hold in mid-June, the market priced in about 43 basis points of tightening for this year. That fell to 26-27 bp after last week's data, the lowest since the day before the June FOMC meeting.
Yet the Middle East war re-escalated, and the S&P 500 and Nasdaq came under heavy profit-taking. Foreign demand for US equities is a key channel funding the US current account deficit, traders note. Over the last 30 and 60 sessions, the dollar index has been more correlated with the S&P 500 than with the Nasdaq. That relationship could amplify the safe-haven bid if equities continue to slide.
The euro remains highly sensitive to US rate expectations. The 30- and 60-day correlations with the two-year US yield are near multi-year extremes of -0.70 and -0.75, respectively. Those are more robust than the correlation with the two-year rate differential. The ECB meets Thursday and is all but certain to hold rates after the June hike. The swaps market prices about 22 bp of tightening for the September meeting, when staff will update economic projections. The euro reached a four-week high near $1.1485 mid-week but gave back most of those gains to settle around $1.1380. Momentum indicators look more constructive than the price action. A break below last week's low near $1.1380 leaves little support ahead of the year's low at $1.1325.
The dollar was the only G10 currency to gain against the yen last week. The 30-day correlation between USD/JPY and US two-year yields has fallen from a peak of 0.65 in May to below 0.40. Finance Minister Katayama renewed intervention threats and suggested pension funds boost domestic allocation to Japanese assets. Japan's markets are closed Monday for Marine Day, some traders see intervention risk after Friday's verbal warnings. The dollar held above JPY162, with the five-day moving average creeping higher. Data highlights include June trade balance and national CPI. The Tokyo CPI already rose from 1.4% to 1.7%, and the core measure from 1.3% to 1.6%. A similar move in the national reading would lift headline to around 1.8% and core to 1.7%, still below the 2% target.
Cable reached a two-month high near $1.3560 mid-week on speculation that Home Secretary Mahmood would be named Chancellor of the Exchequer. It pulled back to $1.3425 before the weekend on the broader dollar strength and risk-off mood. That retraced 61.8% of last week's gains. The Labour Party's leadership challenge ends July 17, and Burnham will formally become prime minister on July 20. The BOE meets July 30 with no change expected. Sterling's 30-day inverse correlation with US two-year yields is near -0.60. Support is seen in the $1.3380-$1.3400 band, which houses the 200-day moving average and the July 15 low.
The US two-year premium over Canada narrowed from about 145 bp at the start of July to near 130 bp after weaker US jobs and inflation data. That helped the Canadian dollar post its first back-to-back weekly gain since late April. USD/CAD approached psychological support near CAD1.4000. The 30-day correlation between the exchange rate and the interest rate differential is near 0.67, the highest in more than three years. Canada reports June CPI and retail sales this week. Headline CPI has run at an annualized pace of a little more than 7% through May, the underlying median and trimmed core measures average 2.05%, and the Bank of Canada puts more weight on those.
The Australian dollar is highly sensitive to US two-year yields. The 60-day inverse correlation is near -0.69, close to the most in a decade. The Aussie reached a one-month high near $0.7020 mid-week before pulling back to $0.6965. Australia reports June jobs data Thursday and preliminary PMI Friday. The RBA meets August 11 and is seen on hold until at least Q4. The composite PMI has been chopping around the 50 threshold.
The Mexican peso is sensitive to the dollar's broad direction, with a 30-day correlation with the dollar index near 0.70. The dollar tested the lower end of its recent range near MXN17.3575 mid-week before recovering to MXN17.55. The upper end of the range is MXN17.6450-MXN17.6765. A more serious test for the greenback may be the 200-day moving average near MXN17.71, a level the dollar has not settled below since April 2025.
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