US Dollar Outlook: Inflation Data Make-or-Break for DXY

• US Dollar price action trading on its front foot largely due to the threat of Fed tapering

• EUR/USD weakness, USD/JPY strength driving the DXY Index 1% higher month-to-date

• Upcoming CPI data likely to weigh on the FOMCs transitory narrative and fuel volatility

US Dollar bulls have clearly controlled the steering wheel over the last few days. The broader DXY Index is up more than 1% on the month largely thanks to US Dollar strength against key peers like the Euro and Yen. In fact, EUR/USD and USD/JPY, which are the two largest components of the DXY Index, have both reflected US Dollar gains for seven consecutive trading sessions.

Whether or not the US Dollar can sustain its bid in the short-term hinges largely on inflation data on deck for release. The monthly US CPI report is scheduled to cross wires Wednesday, 11 August at 12:30 GMT. Markets are expecting the latest year-over-year inflation data to come in at 5.3% and 4.3% for headline and core CPI, respectively. Of particular note, however, will be the month-over-month readings.

This is considering the market forecast is for both headline and core inflation to decelerate quite a bit on a month-over-month basis. Specifically, the consensus estimate is for headline CPI to drop to 0.5% in July from 0.9% in June and core CPI to fall to 0.4% in July from 0.9% in June. That would likely bode well for FOMC officials and their transitory inflation narrative.

As such, in-line or lower-than-expected CPI data could see a bearish reaction by the US Dollar. On the other hand, if the CPI report comes in hotter than expected, that would likely keep the pressure on the Fed to announce its taper timeline sooner rather than later, and we could see the US Dollar extend its stretch of strength in turn.

High-impact CPI data due and its make-or-break potential for US Dollar outlook is underscored by the latest overnight implied volatility readings. EUR/USD overnight implied volatility of 7.1%, for example, compares to its 20-day average reading of 5.2% and ranks in the top 78th percentile of measurements taken over the last 12-months.

Likewise, USD/JPY overnight implied volatility of 6.8% compares to its 20-day average reading of 5.3% and ranks in the top 88th percentile of measurements taken over the last 12-months. That all said, traders might want to keep an eye on how Treasury yields react to the upcoming inflation report given their collective posturing as a bellwether to where the US Dollar heads next.