Dollar eases as stocks push higher

The US dollar fell, allowing the likes of GBP/USD, EUR/USD et. al., to recover in the first half of Thursday’s session. There was no obvious trigger for the dollar selling, but FX traders got their direction from equity markets where risk sentiment improved after a lacklustre session on Wall Street the day before, when equity indices closed lower. US futures bounced back along with the European markets, where the UK’s FTSE 100 again hit a new record high, and the German DAX jumped more than 1% to track a positive session in China. What’s driving the optimism and will the positivity last?

What’s driving the optimism?

 

It appears as though investors are cheering any piece of good news that come their way. Today, sentiment was boosted after latest German inflation data showed an unexpected cooling to 9.2%, down from 9.6% and well below forecasts of a return to double-digit inflation of 10%. On top of this, company earnings from the likes of Siemens and AstraZeneca were well received. In addition, the lack of any further negative news encouraged the bears to cover some of their short bets, alleviating pressure from indices and beaten down currency pairs.

What about rising US interest rates expectations?

 

Investors have now had several days to digest that surprisingly strong US employment report and what it meant for monetary policy. Initially, the markets responded in the way you would expect: the dollar jumped, and gold slumped, while equity markets turned choppy, as investors priced in more rate hikes than had been expected. Some hawkish Fed commentary followed, although this was countered by the Fed Chairman Powell who did not appear too alarmed. With equity markets holding their own relatively well, and the dollar resuming lower, it looks like the market has decided the strong jobs data shows the economy is resilient and that inflation may be cooling down anyway as wages grew in line with expectations.

But is this view justified?

 

Are we going to see renewed strength in the dollar, and will that weigh on risk appetite?

A lot will now depend on incoming data. As we have seen with the release of German CPI data today, the market is very sensitive to inflation data as that’s precisely what central banks are also watching. It is all about front-running central banks.

The reaction to Jay Powell’s speech on Tuesday was a positive one for risk assets, which meant that the dollar would come under pressure given its general negative correlation with stocks. Did the Fed Chair say anything dovish? No. Was he super hawkish? Again, no. He was deemed neutral overall. Powell acknowledged that the disinflationary process is underway, but also suggested that interest rates may have to be pushed even higher if jobs data continues to show upside surprises. So, the dollar may yet make a comeback.