Another burning hot U.S. inflation print has sent bond markets to price in aggressive Fed exchange rates, but the dollar is trading as inflation has already peaked. Is this a turning point for the FX market? The Fed’s next few minutes and U.S. retail sales could reveal whether the gamebook has really changed.
Dollar did not impress
Will the Fed pull the trigger? That’s what the market is betting on after the latest rise in inflation. Six and a half rates are now priced for the year, the probability of a “double” rise in March has hit the roof, and there is all sorts of speculation about an emergency meeting of the Fed, which is already called for this month.
Bond markets basically say the Fed has lost control and must take a sledgehammer to inflation. However despite the fireworks in returns, the FX market has not really played. The dollar moved higher eventually, but it was a very late reaction and not particularly impressive considering that the market priced one additional rate in a few hours.
There are several ways to interpret this lethargic shift. For example, many big players may have been positioned for a hot press or felt that the resulting shock-and-fear rate hikes to stave off inflation could ultimately fail and trigger a recession.
The reason is not so important. What matters is the price action. There has been a consistent pattern in recent weeks where the dollar cannot take advantage of “good” news even as Fed bets rise. This suggests that the uptrend, which has been in place for more than a year, is losing steam.
Let’s break it. The Fed is now almost ‘full price’. In fact, markets may have gone too far. There is a serious argument that the annual inflation rate could peak soon as government spending fades, supply chains eventually recover, consumers return to services with restrictions lifted, and year-over-year comparisons become much more difficult from March onwards.
When investors see concrete signs of ‘peak inflation’, these hyper-aggressive Fed bets could be retracted. Politics is not favorable either. Democrats are likely to lose Congress in the November midterm elections, which means the days of extravagant government spending are over. This also implies that “peak growth” may be behind us.
Last but not least, the Fed is no longer playing alone. Foreign central banks including the ECB have begun to become receptive, so the interest rate advantage of the dollar is unlikely to increase.
That said, the dollar may have a “last rush” while markets speculate on a double rate hike in March, but the general buildup appears to be on its final stages. It’s just hard to see much of the top left with the Fed already pricing so aggressively.
The minutes of the latest Fed meeting and retail sales for January will both be released on Wednesday. The minutes are likely to be out of date due to recent developments, so the focus will be on retail sales. If the ratio is solid but the dollar cannot capitalize again, it would be another sign that the picture is turning.
A barrage of UK editions
A lot of British data is coming in, starting with the latest job report on Tuesday. Inflation statistics for January will hit markets on Wednesday, ahead of retail sales on Friday.
The Bank of England raised rates last week and began lowering its balance sheet, but the pound could not rise and instead lost significant ground against the euro as the ECB also switched on the switch. Money markets are now pricing another six BoE rates for this year.
In the euro area, the second estimate of GDP for Q4 came out on Tuesday, although the euro generally did not react much to it.
Canadian and Australian data
In Canada, the latest inflation report will be released on Wednesday ahead of retail sales on Friday. The nation’s economy is booming, though sales figures may be fairly sluggish amid December’s covid restrictions.
The Canadian dollar has been a real enigma lately, as it has diverged from economic data and rising oil prices, instead trading in lockstep with stock markets and risk appetite. That said, the outlook remains favorable as correlations could eventually return and the broader inflation environment bodes well for commodity-exporting economies like Canada.
In Australia, the minutes of the latest Reserve Bank meeting are released on Tuesday, ahead of employment data on Thursday. Both could be crucial for the aussie, as markets will price more than six rates for this year, despite the RBA’s reluctance to signal anyone.
Japanese and Chinese inflation
The yen has come under heavy fire lately, losing ground across the board as yields and commodity prices have shot higher. Inflating global yields are bad news for the yen, as the Bank of Japan remains committed to its strategy of controlling a yield curve that holds a cap on the nation’s yields.
Therefore, Japanese yields cannot keep up with foreign and tariff differences are automatically widening against the yen. For the currency to stage a return, markets must see signs that the BoJ could raise this ceiling. This further highlights the upcoming GDP and inflation numbers on Tuesday and Friday respectively.
Finally in China, inflation statistics for January will be released on Wednesday.