Dollar bulls charge in as inflation speeds up

The U.S. dollar soared on Wednesday on reports that consumer prices rose at their fastest pace since 2008.  Federal Reserve Chairman Powell warned about a temporary rise in prices but no one expected such a strong increase. On a month to month basis CPI rose 0.8%, four times more than expected and year over year the CPI rate was 4.2% versus 3.6% estimate. Fed Vice Chairman Clarida said he was “surprised” by the sharp rise in inflation leaving investors wondering if today’s report raised eyebrows for other policymakers.
 
Stocks tumbled as rising prices affects business margins, drives yields higher which affects borrowing costs and puts pressure on the Federal Reserve to reduce stimulus. For now, policymakers will hold firm to their view that this increase is transitory but many investors are worried that the robustness of the recovery will make price increases durable. The return of consumer demand and supply shortages drove the price of food, airfare, car rental, used car sales and gas sharply higher. It is hard to see demand abating and price growth slowing materially before the end of summer. The longer prices remain high, the more likely they will become permanent.  
 
The U.S. dollar should hold onto its gains going into Friday’s retail sales report. Between higher inflation and stronger wage growth, there’s a good chance for a consumer spending surprise.  Economists are only looking for retail sales to grow 1% after 9.8% increase the previous month. Like inflation this may turn out to be an unusually low forecast. USD/JPY enjoyed its strongest one day rally since early March and could test 110 before the end of the week. Producer prices are due for release tomorrow but after CPI, PPI should have little impact on the dollar. Instead, traders will be focused on weekly jobless claims after the last non-farm payrolls reports.
 
The New Zealand and Australian dollars were hit the hardest by the sell-off in stocks, losing more than 1.5% of their value against the U.S. dollar.  Both countries are enjoying low COVID cases, strong housing markets and healthy recoveries but they are high beta currencies that are generally very sensitive to risk appetite.   The Canadian dollar also ended the day lower but it was the most resilient, losing only 0.2% of its value versus the greenback.
 
Euro started the day under pressure following weaker than expected industrial production numbers. The U.K.’s economic reports were overwhelmingly strong but sterling was unable to avoid losses. The U.K. economy contracted -1.5% in the first quarter while industrial production rose 1.8%.  With no major Eurozone or U.K. data due for release later this week, euro and sterling will trade primarily on the market’s appetite for U.S. dollars.