Dollar squeezed as firm inflation pressures Fed

Overnight Headlines

*US stocks were higher after sticky US CPI

*USD eased from Tuesday’s one-year high

*Gold had its best session in seven months, nears resistance

*Bitcoin rose 1.5% to $58,550, its highest level since May

*China factory-gate inflation surges to highest on record

US equities were mostly higher with the Dow closing flat while the S&P500 and Nasdaq rose 0.3% and 0.7% respectively. The latter snapped three days of declines but is still lower on the week. FANMAG outperformed with materials while the inflation/stagflation trade stalled. Asian markets are in the green, US and European futures as well.

USD pulled back on firm US inflation data which has actually been the norm recently. The last seven CPI releases were in-line or above estimates and the dollar strengthened in only two cases, in May and July. EUR/USD rose the most since August and is nearing first resistance at 1.1604. GBP gained 0.5% and is trading close to last week’s high at 1.3673. USD/JPY tracked lower US Treasury yields, though is firmer this morning.

Market Thoughts – Fed minutes and CPI continue theme

We had another solid increase in US consumer prices with the headline inflation number up one tenth to 5.4% and the core unchanged at 4%. Nothing in the report suggest the high inflation/stagflation story is going away anytime soon. The FOMC minutes showed policymakers’ growing concern about inflation and agreement to start tapering soon, which will end in July at the latest. However, it’s clear there is disagreement around the labour market and when to hike rates and by how much.

Money markets reacted by bringing forward rate hike expectations but lowering the forecast peak. Fed Funds futures pulled forward the first hike from late 2022 to almost a full 25bp hike by September. Rates in five years’ time will still hover around just 1.5%. With bond yields falling back, this all seems to be a reflection of the market pricing in a policy mistake, that is the Fed potentially going too early and aggressive in tightening policy.

Chart of the Day – DXY falls below near-term trendline support

The dollar has consistently failed to benefit from higher inflation numbers after the release, as noted above. Yesterday was no different with the DXY falling from one-year highs made the day before at 94.56. But the Fed policy outlook still looks supportive of the greenback with rising price pressures forcing policymakers’ hands. The broader risk backdrop also continues to face a number of challenges which should mean USD retains a broadly firm tone.

DXY looked to be making a bullish continuation pattern in the form of an ascending triangle. Higher lows were hitting resistance around 94.45 with pressure building for an upside break. But yesterday’s move lower looks to have unsettled long dollar positioning, which is at its highest level since mid-2019. The upward trendline from mid-September has also been broken with first support around 93.93 and then 93.68. Resistance above is at 94.65 and the September 2020 high at 94.74.


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