Accelerating US inflation weighs on stocks, strengthens USD

The US consumer price index accelerated by 8.6% in May from 8.3% a month earlier. The new data exceeded expectations, rebutting hopes that US inflation is already slowing.

Today’s inflation report is the last big release before the Fed meeting next Wednesday. A renewal of inflation to 40-year highs will surely attract the public’s attention at the weekend and will pressure the Fed.

Potentially, such high reading could trigger a tougher FOMC stance in the accompanying commentary. Recently, the Fed has been expected to raise rates by 50 points next week and hints of another such move in late July.

However, with a strong labour market and persistently high inflation, there are increasing chances that more such double-sized rate hikes are required, which is speculatively good news for the dollar in the coming weeks.

A separate issue is quantitative tightening. The Fed could also adjust its plans to sell assets off the balance sheet to tighten financial conditions in the country further. Proponents of such an approach point to the record amounts of excess liquidity that commercial banks are parking on central bank balance sheets.

High inflation is bad news for the stock market because it will force the Fed to tighten the monetary policy screws even further. The Fed’s open intention to suppress inflation creates risk-off market sentiment when the price growth remains high. In this environment, dollar-denominated money market assets become attractive because of higher yields.

This is in stark contrast to last year when the Fed reassured us that everything would pass itself, so investors preferred to sell dollars that were losing value.

The FxPro Analyst Team