Fed’s look beyond inflation fears will hurt the dollar

Pressure on equity markets returned on Wednesday evening, causing a 2% fall in the Dow Jones index and a 2.7% dip in the Nasdaq100. Winding down risk-on positions on Thursday has extended well beyond the rotation from teсhs to value stocks yesterday, as fears of inflation triggered a flurry of revaluation of yields.

The dollar enjoyed upside momentum, almost regaining losses after the weak jobs report, as traders in the markets returned to expectations of an imminent tightening of monetary policy in response to the inflation data.

The latest surge in volatility is a clear indication of overheated valuations in the markets, making traders’ reaction to weak data particularly wild. However, it is worth noting that yesterday’s reaction was overly impulsive.

Consumer price growth for April was 0.9% for the core CPI measure, excluding food and energy. This is the sharpest one-month jump in the index since the heydays of raging inflation in the early 1980s.

The most significant contributors to the surge in April were the prices of used cars and transport services. These components are included in the core price index as they are not volatile. However, we saw them jump more than 10% for the month in response to paycheques and the opening of the economy. These are short-term factors that are unlikely to remain in place going forward.

In our view, it is unlikely that the Fed will mechanically react to the price spike with more hawkish rhetoric. And right now, this is helping the dollar.

We would hazard a guess that the Fed will not be surprised by the price hike and will continue to call the situation “transitory” and again reassure markets that it will maintain an ultra-soft monetary policy. This will keep shares from being volatile and support the labour market recovery.

The Fed cannot do it without risking triggering a second recession which would be good news for commodities and equity markets but bad news for the dollar.

The RSI on the daily charts of the Nasdaq100 yesterday fell to 33, the lowest value since March 2020. This is a clear reflection of sellers’ pressure. However, it also makes the markets appear optimistic, suggesting that local oversold conditions will attract buyers confident in the long-term outlook for the economy and equity market.

This cautious buying is reflected in purchases of US index futures and renewed pressure on the dollar. However, only words from Fed officials suppressing inflation fears can give the market a powerful impetus.

The FxPro Analyst Team