Outlook: We get Sept CPI this morning, forecast at the same 5.3% as in Aug with core also at the same 4%. Many central bank policy-makers in the US and elsewhere admit that it’s going to take longer than we thought to get inflation back down to “normal” and many analysts will waste time scouring today’s Fed minutes for hints.

Bloomberg reports Atlanta Fed Bostic really dislikes the word “transitory.” It doesn’t mean “ending quickly” but rather "this is related to pandemic-driven changes to supply and demand that will fade as commerce normalizes, and as such tighter monetary policy isn't the solution."

Two issues: it’s obvious that monetary policy has nothing to do with containers located in the wrong places and other supply chain disruptions. The hawkish tone at the Fed, BoE and elsewhere has to do with managing sentiment, including attitudes toward central banks, and especially the large sub-group of inflation worry-warts. The Fed doesn’t know any better than anyone else how long inflation in some sectors will last. But the Fed sees rising wages even if new employment is not as high as expected, and that alone justifies a less dovish stance.

The Fed admitting inflation is not returning to normal any time soon is intended to influence two population sub-sets. First is the general public, where Fed research indicates the expectations/self-fulfilling prophecy aspect might by a dud and not true after all. Second is the bond gang, who are getting so much early warning that a taper tantrum would make them look stupid—but that doesn’t mean no foot-stamping. Nobody likes uncertainty on this scale and none less than the bond gang. Funny enough, some of them are the first to complain that raising rates can’t fix broken supply chains. Well, it’s not intended to.

There is a non-zero chance that if CPI matches the month before as expected --no increase—this can be interpreted as “not worsening” and therefore “good.” This is not true, of course. The absence of acceleration is not evidence of deceleration. Inflation rates can remain in the 3.5-6.5% range for a very long time, Still, if the market sees “not worsening” as “good,” we expect the yield curve to get less steep and the 10-year to dip, which it may be doing already ahead of the release. This in turn may account for the dollar getting wobbly, which otherwise can be explained only by big-player positioning. 

In FX, it’s not always the rates, but often it is. Or rather the yield differential and the expectations for the yield diff. If the US has 1.60% in the 10-year and Japan has 0.096%, the US and the dollar are favored, especially because the US will be getting higher returns within a year and the probability of higher returns in Japan is as close to zero as you can get. Nevertheless, the implication is that if US inflation is the same this time, yields will fall, if only a little, and despite the big picture, the yen will rise as shorts jump ship.

The same effect is visible in the USD/CAD, where the dollar is otherwise unaccountably lower. But US rates fell while the Canadian rates didn’t budge, so an extreme move against the dollar. It could be argued that the BoC will move before the Fed does, or at least talk like it, but you don’t need to go that far. The widening differential is nice and will suffice.

It goes without saying that this kind of tap-dancing is exhausting, not least because if a move in an FX rate is big enough, it triggers the algo traders and it takes only one or two to set off a bandwagon in the illogical and counter-trend direction. Such moves tend to last only a day or two, instead of the usual 3-5 of a “normal” pullback, and wreaks havoc on trend-followers.

Goldman’s stance on “transitory” inflation carries the caveat that its forecasts are high probability only if the supply constraints get fixed. Gee, no kidding. It sees inflation at 4.3% at year-end and down to 3.5% in 2022. Tapering will be announced in November, as universally expected, and will end at mid-2022. Expectations of two or three rate hikes by 2023 are overly high and hikes will be more gradual. As for growth, the US will get 5.9% this year (close to the IMF’s 6.0%), 5.0% next year and 2.4% in 2023.

Goldman doesn’t emphasize it, but its forecast of inflation at 4.3% by year-end is a full 1% lower than 5.3% in August and likely September. In other words, supply chain constraints may still exist but US inflation could be already moderating by year-end. What does this mean for yields? It could mean that US yields drop—again!—and the dollar loses ground in a more meaningful way against everything, but more so against the higher-yielding currencies, mostly emerging markets. Think peso.

This is just one narrative of several likely scenarios. Inflation hawks are still prowling the skies. But Goldman has a pretty good track record. (By the way, open a savings account for as little as $100 at Goldman’s retail savings arm Marcus and get access all kinds of research.).


This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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