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Faltering US inflation expectations have emboldened the market to mark down its expectations of the Fed rate path. This has robbed the dollar of yield support. Absent a shock result in the French election, the euro should rally, and the rally will be supported by ECB tightening later this year. The waning of the China tail risk should also support commodity and high-carry currencies. Look to sell the yen again once US yields find durable support.
The yield on 10yr US TIIPS edged back up to 35bp and the dollar duly stabilized.
The Beige Book however did nothing to really encourage market expectations of a mid-year Fed rate hike, fueling concerns that maybe there will be only one further hike in 2017.
The Fed's biggest challenge may be that inflation expectations are still falling, steadily decoupling from its 2% target.
It's hard to see bow the Fed can remain hawkish against a backdrop of falling inflation expectations and hard, in the process, to see the dollar getting more than a nominal bounce until there is clearer signs of economic robustness.
USDJPY has been faithfully following real yields, and does look increasingly like a buy closer to 105. AUDJPY may come back into its own at around the same time. We just can't see the justification for US real yields to fall all that much further, and stability around here may be all that is needed to get USDJPY trending back up within the current trading range.
The bigger dollar story remains against the euro. French election polls continue to show the top four candidates' poll rankings bunching around 19-23%, which will keep markets nervous, though the only major risk to the market is that Le Pen and Mélenchon make the second round together - something that is getting slightly less likely as M. Mélenchon's poll ranking fails to break above 20%.
