USD Sell-Off Sparks Concern: Is USD/JPY Carry Trade the Culprit?

The US dollar (USD) is facing an unexpected downturn despite strong fundamental factors that would typically drive it higher. The Consumer Price Index (CPI) came in at 3.4% for headline and 2.4% for core, while inflation expectations rose in the University of Michigan survey.

These numbers would normally be a green light for the USD, but instead, it's been falling against the Japanese yen (JPY). The ECB hiked rates by 25 basis points, but this move was largely priced-in before the announcement. Treasury yields spiked, and oil prices rose above $100 per barrel.

The US Federal Reserve is expected to raise interest rates next week, with a 90% probability of a hike and nearly 70% chance of another rate increase by year-end. However, these expectations haven't translated into USD strength, suggesting that something else is driving the market.

A likely culprit behind the USD's weakness is the unwind of the crowded USD/JPY carry trade. US Treasury Secretary Scott Bessent recently spoke about the Bank of Japan's intentions, which may have contributed to the sell-off in USD/JPY.