The read across from any US dollar weakness will be a key input into global risk assets in the week ahead. Whether it is a correction within an ongoing mega-bull trend for the greenback or the start of a major reversal lower, it will feature in most trader conversations. Inflation developments in the US and Europe will play a role in the currency and risk asset outlook.
US CPI on Tuesday will be the biggest data point, with Europe also due to report inflation this week. Michigan expectations numbers on Friday will influence the Fed narrative just before its communication blackout period commences.
The US currency had a rough end to last week, partly as policymakers from the greenback’s biggest rivals came to support their exchange rates. The European Central Bank’s three-quarter point rate hike signals it will stay aggressive brought the euro back above parity, while Bank of Japan Governor Haruhiko Kuroda’s well-timed jawboning lifted the yen. But none of that will matter as much as Tuesday’s US inflation report and the reactions it elicits from Fed officials.
US inflation likely slowed for a second month in August as gas prices continued to drop, but that probably would not be enough to stop the Federal Reserve from delivering another jumbo rate hike later this month.
Tuesday’s Consumer Price Index, landing during the central bank’s pre-meeting quiet period, is the last major report they will receive before they make a decision. Economists forecast an 8.1% rise in August from a year earlier, which would be the second-straight deceleration.
That is unlikely for investors’ bets to shift that the US central bank will lift rates by 75 basis points for the third time in a row when officials meet in a week, trying to stamp out the worst inflation in a generation. Those expectations were solidified Thursday after Fed Chair Jerome Powell reiterated that policymakers would not back down and Friday when some officials voiced their support for another large move.
While a decline in price growth would be welcome, it would still point to inflation that is far too high for the Fed’s comfort. Also troubling to Fed officials is that outside of gasoline, price growth in the economy is rampant. While the overall CPI is expected to post its first monthly decline since the early months of the pandemic, the core measure, which excludes volatile food and energy prices, is still projected to rise.
Powell and his colleagues have said their decision will be based on the “totality” of the economic data they have on hand when they convene on 20th-21st September. That includes the latest jobs reports, which showed better-than-forecast payroll growth in July and August. An improvement in consumer sentiment figures and a surprise pickup in job openings also point to resilient households and consistently strong labour demand.
The Fed is overwhelmingly expected to deliver another three-quarter point hike of their own. However, a soft CPI print followed by central bank comments that offer scope for a slower pace after September could confirm that the dollar has topped out this cycle. So far, rate swaps keep pushing the expected Fed path higher, even as inflation expectations ease. Until that dynamic shift, this dollar strength will likely sustain.
Fullerton Markets Research Team
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