Week in review: from the CPI shock to tense calm ahead of Fed week

Markets closed, time to take stock. This week had it all — and the final balance is better than half of traders would have signed off on Wednesday at noon when the CPI came out.

The week in retrospect

On Wednesday, the May CPI came in hotter than expected, and the immediate reaction was the usual one: strong dollar, bonds under pressure, emerging markets punished. USD/MXN went as high as 17.45, the VIX climbed to ~21, and the market began to price out any room for the Fed to cut rates for the rest of the year.

What happened next is the interesting part: the bonds didn't break. The US10Y rose, yes, but in an orderly fashion — without the chain selloff that characterizes moments of genuine inflationary panic. That gave the market the cover to shift back to risk-on through Thursday and Friday. The VIX fell to 17.7, the dollar gave back some ground, and the peso recovered nearly all of its losses, ending the week at 17.22.

What matters in carry

The net long position in the peso held by speculative funds (CFTC data) remained high despite the turbulence. That is the strongest signal that the MXN carry trade remains the consensus among institutional players. The Banxico-Fed differential (+2.87 percentage points) justifies the position, and as long as that number doesn't change dramatically, the peso has a natural floor.

The week ahead

The central event is the FOMC on Wednesday — and this time with the hot CPI as a backdrop, Powell's press conference will be under more scrutiny than usual. If Powell holds a neutral tone (no signals that the Fed is considering a hike), the market will likely stay on its current path and the peso has a clear run toward 17.10-17.15. If he surprises to the upside on hawkishness, the carry trade gets complicated and we move quickly back to the 17.40+ zone. The base case remains neutral-to-favorable, but the tail risk is real this week.