Is the dollar poised for a pullback amid upcoming inflation data?
James Chen, CMT May 7, 2018 6:06 PM
As the US dollar started breaking out in earnest two weeks ago, many currency traders saw the dollar’s rise as long overdue, given the clear signs of climbing inflation, surging bond yields, and higher interest rate expectations from the Federal Reserve that have prevailed for many months.
As the US dollar started breaking out in earnest two weeks ago, many currency traders saw the dollar’s rise as long overdue, given the clear signs of climbing inflation, surging bond yields, and higher interest rate expectations from the Federal Reserve that have prevailed for many months. For much of 2018 thus far, the dollar had stubbornly wallowed near multi-year lows, pressured heavily by prolonged bearish sentiment despite the growing monetary policy divergence between the Fed and other key central banks. The past two weeks, however, have seen a redemption of sorts for dollar bulls, as the greenback has risen sharply against its major rivals.
The key question now is whether this rally will continue to extend higher. Last week’s FOMC decision gave some hints that although the Fed does see inflation on the rise and close to hitting its 2% target, the central bank may potentially allow inflation to run higher without necessarily becoming more aggressive in raising interest rates. Though these hints from the Fed are not dollar-supportive, the US dollar index rose to a new year-to-date high after that release, boosted in part by the Fed’s robust inflation expectations.
As for Friday’s US jobs report, lower-than-expected job creation and wage growth figures disappointed expectations. Overall, the data clearly showed relative weakness, but was likely not enough of a disappointment to keep the Fed from raising interest rates two, or possibly even three, more times this year. While the dollar initially dropped on the worse-than-expected jobs data, it later pared those losses as confidence in a still-hawkish Fed continued to prevail.
As it currently stands, the US dollar index is trading within a tight consolidation around its new year-to-date highs. Monday saw yet a new high established just off the 93.00 level and above the key 92.50 support/resistance area. At this juncture, much of the market expectations for rising inflation and interest rates may already have been priced into the dollar, and upside momentum may have been overextended. Furthermore, weak wage growth figures and a Fed that may be willing to allow inflation to run hotter before getting more aggressive, are both factors that are not conducive to an extension of the dollar rally. With any dollar index pullback below the noted 92.50 level, the next key downside target on a correction of the recent rally is back down around the important 91.00 support level. This week, both the US consumer price index (Thursday) and producer price index (Wednesday) inflation readings will also likely impact the dollar amid the mixed inflation signals that the market has been receiving from recent economic data.
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