The USD has dipped back as traders expect the Fed to be more cautious in terms of interest rate hikes as aggressive hikes could cause a recession. Our view is the market are to optimistic about the Fed being cautious with interest rate rises and the dip in the US Dollar Index (DXY) is a buy…
Global equities have rallied and so to have risk currencies and the USD has dipped lower: “Global equity markets are putting in a little run of gains. The positive story seems to be that Fed Chair Powell’s admission last week of the risk of recession means that global monetary tightening may not be as sharp as expected – and that’s good news for equities. Quarter-end and half-year-end rebalancing may help equities and soften the dollar this week.” (INGTHINK)
We don’t see too much more downside the Fed will have to remain hawkish despite the risks of a recession as inflationary pressure still remains too high…
Fed to Remain Hawkish
This week we have PCE data on Thursday an (the PCE) price index, a key measure of US inflation, increased 6.3% in the year to April, down from 6.6% in March. Meanwhile, the core which excludes food and energy costs rose 4.9% in the year to April, also marking a slowdown from the March figure of 5.2%. It was the second successive monthly decline in core PCE since the February high of 5.3%.
Will this change the Feds view on rate hikes if we get a slow up?
We doubt it while it has been seen as the Feds preferred measure of inflation in the past it isn’t now as the Fed has noted it’s now focused on headline inflation which looks set to remain elevated going forward.
US Inflation to Remain High and No Big Fall Soon
In terms of the USD the May CPI report set a new peak on year-on-year inflation of 8.6%. July’s CPI report should show similar readings similar to May with headline inflation at 8.7-8.8%. We could also see year-on-year headline inflation could easily rise above 9%.
The Fed is primarily focused on monthly and quarterly readings on core inflation to judge underlying inflation pressure, but the latest forward guidance from the June FOMC meeting indicates that the committee is also concerned about how headline inflation shapes inflation expectations of consumers.
The rise in headline inflation will make headlines in the media and keep the pressure on the Fed to remain aggressive in terms of hikes going forward especially as we come into the mid term elections.
Recent data shows that headline inflation continues to the upside but core has dropped slightly – we don’t expect a big fall as services inflation which will rise further as a shortage of workers means higher wages which companies will pass on to consumers in the form of higher prices.
The Fed will go ahead with another 75bp interest rate hike in July and will continue to be hawkish into the end of the year. Just a week after the June FOMC meeting, several FOMC officials (Waller, Kashkari, and Barkin) supported A 75bp hike
A Slowing US and Global Economy is Bullish for the USD
The USD offers not only attractive interest rates but is also a safe haven that will keep it firm in the coming months.
The chart below shows the big trend in the DXY is up and the key levels of support and resistance to watch. The correction in our view is a buying opportunity.