Fundamental Forecast for the US Dollar: Bullish
- US Dollar gains most in 15 months as markets eye steep Fed rate hike cycle
- CPI data may drive continued recovery if inflation is stronger than expected
- Worries about aggressive stimulus withdrawal might inspire risk aversion
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The US Dollar scored its best week in 15 months as the aftermath of January’s explosive labor-market data continued to play out. That report showed that wage inflation surged to an 8-year high of 2.9 percent. That stoked speculation about an unexpectedly aggressive Fed tightening cycle, sending the greenback higher and punishing risky assetsthat had been buoyed by nearly a decade of ultra-loose monetary policy.
Equity markets offered the most obvious display of weakness. The MSCI World Stock index shed 5.75 percent, the most in over two years. Close to 80 percent of all monetary transactions involve the US Dollar, so when the Fed pushes up the cost of borrowing in the benchmark currency, it makes credit broadly more expensive on a global scale.
The week ahead is likely to see this narrative remain at the forefront as the spotlight turns to January’s US CPI report. It is expected to show that headline and core inflation rates ticked down last month. An upside surprise echoing the jump in wage costs seems likely to offer the greenback a further lift, all the while triggering another bout of violent selling across stock exchanges the rest of the risky asset spectrum.
The likelihood of such an outcome seems significant. Survey data from Markit Economics pointed to the continued acceleration in services-sector inflation in January, putting its pace above the trend average. Services account for close to 80 percent of the overall economy, so a slight downtick in still-elevated manufacturing-sector price growth is probably not enough of an offset.
Elsewhere on the docket, retail sales statistics and the University of Michigan consumer confidence gauge are due to cross the wires. These are probably not potent enough to have stand-alone impact on par with the CPI release however. Cleveland Fed President Loretta Mester is also scheduled to speak on the outlook for the economy and monetary policy. Her hawkish lean is well established, so a surprise seems unlikely.
--- Written by Ilya Spivak, Currency Strategist for DailyFX.com
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