Marketmind: Dollar recoil

© Reuters. FILE PHOTO: U.S. One dollar banknotes are seen in front of displayed stock graph in this illustration taken, February 8, 2021. REUTERS/Dado Ruvic/Illustration

A look at the day ahead in U.S. and global markets from Mike Dolan.

All of a sudden, the U.S. dollar's on the backfoot.

After a month of relentless gains to its highest levels in decades, the dollar's DXY index recoiled more than 1% on Friday and was on course for its biggest daily loss since early August.

Perhaps it's just froth off the top, as speculators book profits on already extreme moves.

But there are other significant roadblocks building.

Japan is threatening action - possibly open market buying - to halt the precipitous slide of the yen, with Bank of Japan chief Haruhiko Kuroda the latest to weigh in.

And Europe's central banks are matching the Federal Reserve hawkish anti-inflation stance with jumbo 0.75 basis point interest rate rises of their own, with ECB chief Christine Lagarde explicitly citing the strong dollar as an aggravating factor. The Bank of England will probably do likewise next week, not least with some anxiety over sterling's drop to 37-year lows during the week.

Two-year European bond yields have risen, with the U.S. 2-year yield premium over its G7 partners ebbing.

However, just as everyone goes into a hawkish frenzy, there are hopes of a turn in the inflation picture. And stock markets around the world rallied as the week draws to a close.

Energy price interventions, price caps, subsidies and demand coolants are in the works in Europe, with Britain's energy rescue expected to take up to 5 percentage points off the peak inflation rate there.

Meeting separately ahead of a European Union finance ministers gathering in Prague, French and German finance ministers supported the ECB's move and pledged to work together to support households and businesses through the energy shock and high inflation period.

EU energy ministers will meet in Brussels to discuss oil and gas price caps and other specific measures.

Although crude oil prices tried to get a foothold back above $90 per barrel on Friday, they remain down 28% from the highs of mid-June.

And another indication of easing price pressure was China's inflation rate slowed more than forecast last month, as its economy struggles with COVID lockdowns.

With financial markets now expecting another monthly decline in August's headline U.S. consumer price index next week, the combination of central bank action, energy price relief and recession fears are registering.

At just 2.3%, two-year U.S. inflation expectations embedded in the Treasury market are at their lowest in 18 months, while 5-year inflation 'breakevens' are ebbing back toward 2.5% for the first time since mid-July.

And despite all the harsh rhetoric, Fed policymakers retain their hopes of a 'soft landing'.

"We think we can avoid the kind of very high social costs that Paul Volcker and the Fed had to bring into play" in the 1980s, Fed Chair Jerome Powell said on Thursday.

Any shred of optimism is welcome. Bank of America (NYSE:BAC)'s weekly tally of mutual fund flows showed U.S. equity funds suffering their biggest weekly outflow in almost three months, with technology stocks suffering their biggest exit since 2019.

Key developments that should provide more direction to U.S. markets later on Wednesday:

* European Union energy ministers meet in Brussels; Euro zone finance ministers meet in Prague

* Fed board member Christopher Waller; Kansas City Fed chief Esther George; Chicago Fed chief Charles Evans all speak

* Fed releases quarterly U.S. financial accounts

GRAPHIC: G7 2-Year Yield Spreads vs US https://fingfx.thomsonreuters.com/gfx/mkt/xmpjoabywvr/One.PNG

GRAPHIC: Fund flows: Global equities bonds and money market https://fingfx.thomsonreuters.com/gfx/mkt/zjvqkrnazvx/Fund%20flows-%20Global%20equities%20bonds%20and%20money%20market.jpg

(By Mike Dolan, editing by Kim Coghill; mike.dolan@thomsonreuters.com. Twitter (NYSE:TWTR): @reutersMikeD)