USD/JPY, AUD/USD: Bonds just delivered a message to traders about the US inflation report

• Benchmark US 10-year bond futures rallied on Tuesday before the release of the March US consumer price inflation report (CPI)
• Big bond market moves before prior US inflation reports have often predicted how yields react the day of the release, especially since mid-2023
• We look at USD/JPY and AUD/USD, two FX pairs that can move hard on shifts in US bond yields

The overview

Bond markets make the financial markets go round, so when they provide a strong signal on how Wednesday’s US consumer price inflation report may be interpreted, every trader should sit up and take notice.

The background

Benchmark US 10-year Treasury notes rallied on Tuesday ahead of the March US consumer price inflation (CPI) report. Prices rose the most in three weeks, sending yields down 6.2 basis points, a big move ahead of what is arguably the most important data release markets receive each month.

Positioning may have been a factor with yields hitting 2024 highs earlier in the week. A record block trade in US SOFR futures also occurred during the session, a curious development considering the product is one way traders can speculate on Fed funds rate outlook.

Source: Refinitiv

Such was the size of the move, it prompted me to look back several years to see how yields fared the day the US CPI or PPI report was released, whichever arrived first. I set a limit of at least a two basis point move in either direction to eliminate non-significant fluctuations.

Since the start of 2022, whenever 10-year US bond yields moved two basis points or more the day before the first inflation update, yields moved in the same direction on 13 of 20 occasions on the day of the release. That’s an interesting stat, but one that hardly screams that yields are set to decline further tonight.

However, since May 2023, the success rate stands at six from six. That is, when yields have moved two basis points or more the day before the first inflation report, yields have moved in the same direction the day of its release. That’s noteworthy.

The trade ideas

If US benchmark yields were to decline following the inflation report, it points to an environment of a softer US dollar. That usually assists commodity prices and riskier asset classes given it would likely reflect a greater probability of the Fed pulling forward rate cuts, making June a far stronger possibility for the first move than the coin-flip it’s deemed now.

USD/JPY

With a rolling daily correlation of 0.85 with US 10-year bond yields over the past fortnight, short USD/JPY is a trade option should the pattern continue following the inflation report.

With the threat of BOJ intervention on a probe towards 152 creating extreme caution, shorting ahead of 151.95 with a tight stop above 152 offers decent risk reward should US yields decline, allowing traders to target a pullback to 150.90 or even 150.30, the low struck on March 21.

With short positioning in yen nearing extreme levels, it may not take a significant amount of selling to deliver a meaningful decline in USD/JPY.

AUD/USD

While it doesn’t have as strong a relationship with benchmark US bond yields as USD/JPY, long AUD/USD is another candidate for trade idea given the likely positive spillover effect on commodity prices and risk appetite from a decline in both the US dollar and yields.

After a powerful bullish engulfing candle was recorded to start the week, AUD/USD has kicked on with the move in recent days, seeing it break cleanly through the downtrend it had been in dating back to late December. It rallied above .6600 before stalling at .6642, a level that has capped rallies on several occasions dating back to early March.

In anticipation of yields potentially declining on the inflation report, traders could set longs ahead of .6600 with a stop below for protection. .6642 would be the initial upside target with .6670, the high stuck on March 8, and resistance at .6730 the levels after that. Momentum is to the topside heading into the report with MACD crossing over from below with RSI trending higher.

The wildcards

Past performance does not guarantee future results, so make sure you have an exit plan should recent form not repeat. Adding complexity to the day, a 10-year US Treasury note auction is scheduled to take place after the inflation report, an outcome that could greatly impact bond yields and prices.

-- Written by David Scutt

Follow David on Twitter @scutty