The U.S. dollar index DXY had a strong week last week, rising more than 1.7% to close near 107.00, one of its highest levels since late 2012. While the bullish momentum may be overdone after a year-to-date rally of nearly 12%, the overall outlook remains positive from a fundamental perspective,

U.S. Treasury yields have tumbled since mid-June on expectations the Federal Reserve will take steps to prevent a sharp economic downturn. However, the Fed has yet to give any indication that it intends to hit the brakes, instead, policymakers have signaled that they will move forward with plans to aggressively unwind easing in an effort to restore price stability.

Despite persistent headwinds, macro data continues to look good, especially on the labor market. The June non-farm payrolls report released on Friday showed that jobs added 372,000 jobs, well above expectations for an increase of 268,000, showing that the employment situation remained solid.

Given that employers are still adding workers at a healthy rate to meet customer demand, fears that the economy is slipping into the depths of a recession may have been overblown for a while. Against this backdrop, the Fed is likely to maintain a hawkish stance and continue to tighten monetary policy, at least until there is solid evidence that inflation is easing decisively.

When the U.S. Bureau of Labor Statistics releases the consumer price index (CPI) for June this week, we'll get a better idea of what's going on in inflation. Overall CPI is expected to rise 1.1%, with annualized growth rising from 8.6% to 8.8%, a new cycle high. The result is likely to beat expectations against a backdrop of soaring energy costs, given that gasoline prices hit record highs in the first half of June.

If inflation data for June continues to "burst the table", it could increase market bets for a massive rate hike at the upcoming Fed meeting and put upward pressure on the endpoint rate. According to fed funds futures (April 2023 contract), the endpoint rate is currently around 3.58%.

Taken together, the dollar is likely to remain bullish in the current environment, especially if Treasury yields recover strongly after the recent correction.