Dollar Comes Out Swinging: XM.com

Written by Marios Hadjikyriacos, Senior Investment Analyst at XM.com. An original version of this article can be viewed here.

The US dollar came back swinging this week, after a series of inflation surprises fueled speculation that the Fed will signal a slower pace of rate cuts when it meets next week.

Retail sales disappointed yesterday, but producer prices came in hot. Markets chose to ignore the softening demand outlook and instead focused on the risk of sticky inflation, as consumer prices also exceeded forecasts a few days ago.

It increasingly seems that the ‘last mile’ in bringing inflation down to its 2% target will be the most difficult part, and the recent rally in energy prices adds gravitas to such concerns.

With inflation running persistently hot, the dollar stormed higher with some help from rising US yields, as investors started to position for the Fed meeting next week where the new ‘dot plot’ could signal just two rate cuts for this year, from three previously.

Shares on Wall Street took a small step back yesterday, as indications of cooling consumption from retail sales coupled with stickier inflationary pressures from producer prices proved a toxic cocktail for equities.

Bitcoin also fell victim to the deterioration in risk appetite, having fallen roughly 8% from the new record high it reached on Thursday, as the resurgence in yields led investors to take profits. Gold did not escape unscathed either, but there were some signs of resilience as its retreat was fairly limited, especially when considering how much real yields have risen this week.

In the energy complex, oil prices reached their highest levels since November yesterday, after the International Energy Agency raised its oil demand forecasts a little. Oil prices also benefited from Ukrainian drone attacks against Russian energy infrastructure this week.

If it persists, the rally in oil prices can have repercussions far beyond energy markets as it could keep inflation burning hot for a while longer, complicating central bank plans to slash interest rates this summer. In turn, that could dampen the exuberance in riskier assets like stocks, especially with valuations being so stretched.

The resurgence in global bond yields has turned the yen into the ‘sick man’ of the FX arena once again, despite mounting speculation that the Bank of Japan is about to raise interest rates out of negative territory next week.

While the conditions for a small rate increase are in place with the Japanese economy avoiding a recession, Tokyo inflation reaccelerating, and promising signs from the spring wage negotiations, traders still seem hesitant to bet on any recovery in the yen.

Ultimately, the market is worried that even if the BoJ pulls the rate-hike trigger, it will probably be a ‘one and done’ move. Hence, the rate differentials that have devastated the yen would not narrow significantly, keeping the yen as the world’s primary funding currency in carry trades.

For the yen to mount a sustainable recovery, it requires a wave of global economic weakness that reignites recession concerns abroad and forces heavier rate cuts by foreign central banks. We are not at this stage yet.

Looking ahead, the coming week will be extremely busy for traders, with five major central bank meetings and a ton of data releases on the agenda.