- Dollar slides as CPI numbers increase Fed skip chances
- Fed decides today, spotlight to fall on dot plot
- Wall Street extends rally after soft inflation prints
US CPI data enhance the case for a Fed skip
The dollar traded lower yesterday after data showed that US consumer prices barely rose in May, taking the headline year-on-year rate down to 4.0% from 4.9%. That was the smallest increase in more than two years, adding to the view that the Fed is likely to skip raising rates today. Indeed, the probability of no action is now resting at around 92%.
That said, the core CPI rate only slid to 5.3% y/y from 5.5%, which is still more than double the Fed’s 2% objective. Therefore, investors continued to see a decent – albeit smaller than before the inflation data – probability of a July hike. Ahead of the inflation numbers, investors were foreseeing 20bps worth of a hike for July. Today, they are penciling in 18bps. They are also seeing nearly a quarter-point cut by the end of the year.
Dot plot could support the dollar
With all that in mind, today, market participants will be sitting on the edge of their seats in anticipation of the FOMC decision. Given that they are nearly certain that the Fed will refrain from pushing the hike button after 10 straight hikes, a skip on its own is unlikely to trigger much market volatility. The spotlight is likely to quickly turn to the updated macroeconomic projections and the new dot plot.
If policymakers raise their median dot for 2023, the dollar could still rally despite officials skipping a rate hike, as this could be interpreted as a July rate increase and no cuts for this year. For the dollar to come under strong selling interest, the Fed may need to stay sidelined and signal that they are probably done raising rates, which appears to be the least likely scenario given how high underlying inflation is.
But reversal case remains premature
Having said all that though, even if the dollar strengthens due to a hawkish pause, it may be premature to argue about a potential bullish reversal. After all, investors appeared overwhelmingly willing to sell the greenback when data was supporting the case of a wait-and-see approach at today’s gathering. What’s more, there are more major central bank decisions pending in the days ahead, with the ECB deciding tomorrow and the BoE next week. Hawkish rhetoric by those banks could push the dollar lower against the euro and the pound.
A trend reversal in the greenback seems premature from a technical standpoint as well. The move that could prompt examination of that case may be a decisive break of the dollar index above the 105.50 territory, as such a technical break may signal the completion of a double bottom formation on the daily chart.
Stocks jump on increasing speculation of a Fed pause
Wall Street extended its rally yesterday, with the Nasdaq gaining the most, as the CPI data added more credence to the case of the Fed taking the sidelines today. The tech-heavy index seems to be more sensitive to changes in expectations about interest rates as high-growth tech firms are usually valued by discounting estimated cash flows for the quarters and years ahead. A lower implied interest rate path means higher present values for stocks and vice versa.
The decision by the Chinese central bank to lower a short-term lending rate for the first time in 10 months has also been providing support to equities. Recent data out of China has been suggesting that the post-pandemic economic recovery is losing momentum and thus, People’s Bank of China’s actions were more than cheered by the financial community. Further reduction in rates could be possible on Thursday when the central bank is expected to roll over 200bn yuan in medium-term lending facility loans.
Having said all that though, with the Nasdaq rallying nearly 44% from its October lows and not decently correcting lower since mid-March, the risks of a short-term retreat likely continue to increase. The catalyst for such a correction may be a potential liquidity squeeze due to US Treasury bill issuance.