Tantrum “lite” won’t help US Dollar

US financial markets have had to contend with three “hawkish surprises” so far this month and on each occasion price action has been broadly the same. Initially the Dollar rallied, the S&P 500 sold off and US Treasury yields rose but these (modest) moves were very quickly reversed.

Volatility and directionality have thus remained limited, although the Dollar NEER has slowly weakened to within touching distance of a 3-year low — in line with our bearish Dollar outlook (see Dollar and the three bears, 19th April 2021).

Price action suggests that markets are still seemingly not convinced, rightly in our view, that US inflation will remain materially above target medium-term and that the Federal Reserve will have to tighten monetary policy any time soon.

The question is whether US financial markets will follow the same pattern following today’s release (at 13.30 London time) of US PCE-inflation data for April.

The consensus forecast is that core PCE-inflation — the Federal Reserve’s preferred measure of inflation — rose from 1.8% yoy in March to 2.9% yoy, a 29-year high and well above the Federal Reserve’s medium-term target of 2%.

Our view is that the scope for core PCE-inflation to surprise materially to the upside in April is limited, with the risk to the Dollar based on recent precedent biased to the downside in coming sessions.

Medium-term we think the case for US CPI-inflation to remain well above the Fed’s target is far from water tight. Moreover, the Fed has form when it comes to keeping monetary policy very loose despite decent US GDP growth and an improving domestic labour market.

Our core scenario at present is that the Federal Reserve will only start tapering its monthly asset purchases in 2022 and only start hiking its policy rate in 2023. We therefore remain bearish the US Dollar — a theme we will develop in future FIRMS reports.

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