It is a relatively calm week without any central bank meetings and just a handful of data points. The only event that could spark fireworks is the latest edition of US inflation, which will probably fire up further. If price pressures continue to broaden out into different sectors too, this could set off another cascade of worries around faster Fed rate increases and reignite the dollar’s rally.

 

Not so transitory

Will inflation fade away by itself? This question has tormented markets and central banks recently. It definitely seemed transitory early on. Enormous government spending, paralyzed supply chains, soaring shipping costs, energy prices going ballistic - all these factors can push inflation much higher, but their impact wears off after a while. 

As long as inflation expectations aren’t rising, it’s all transitory’. This was the thinking among central bankers. Well, inflation expectations have finally stormed higher. Derivatives investors are now betting this shock will last much longer, so they are hedging their inflation exposure. 

Chart

But it’s not just supply problems anymore. Wage growth is accelerating, rents have started playing catch-up with soaring house prices, and Congress is about to bring more spending to the party. This is precisely why the upcoming US inflation report on Wednesday will be so crucial. It will reveal whether inflationary pressures continue to broaden out. 

Forecasts suggest the yearly CPI rate will jump to 5.9% in October, from 5.4% previously. But considering the signals from various business surveys, the risks surrounding this forecast may even be tilted to the upside. The Markit PMIs showed companies raising their selling prices ‘at the fastest rate on record’, while the price indices in both the ISM surveys jumped sharply too. 

Chart

Money markets are now pricing in two Fed rate increases for next year, in September and December. Asset purchases will end in June assuming the Fed maintains the current tapering pace. The risk is that markets could bring this entire timeline forward if inflation keeps rising. Tapering could be accelerated so that it ends in May, allowing scope for three rate hikes in June/July, September, and December. 

This spells upside risks for the dollar, especially against the currencies whose central banks could disappoint market expectations for aggressive rate hikes. Those are mainly the Australian dollar and British pound, although the euro falls in this category too. None of these economies are firing on all cylinders, so the current market pricing for three rate increases by the Reserve Bank of Australia next year and almost four hikes from the Bank of England seems unrealistic. 

Chart

In contrast, the two central banks that could match or exceed the Fed in raising rates are the Bank of Canada and the Reserve Bank of New Zealand. The Canadian economy in particular is absolutely booming, so pairs like aussie/loonie or pound/loonie seem vulnerable moving forward - assuming oil prices hold up. 

Australian jobs report eyed

Speaking of Australia, the central bank did its best to push back against market pricing this week. Governor Lowe made it clear that rates won’t rise until 2023 at the earliest and that investors overreacted to the latest spike in inflation. But even after all that, markets continue to expect three hikes for next year. 

Now to be clear, the Australian economy is not that strong. Sure, it remained resilient during the latest lockdown, but the labor market and consumption still took some damage. Meanwhile, iron ore prices are dropping like a rock and China is slowing down, which is a massive risk for the Australian economy that relies on China to absorb its exports. 

Chart

It seems investors are using New Zealand’s powerful recovery as the model for how Australia will perform going forward. The two economies share similar characteristics and usually move in lockstep. This time though, it could be a mistake. 

We will get some more clues on Thursday, when Australia’s jobs data for October are released. It will probably be a strong report thanks to the reopening of the economy, but is that enough to justify three rate hikes for next year? There’s plenty of scope for disappointment when markets are so hawkish. 

Chinese and British data on the radar

The other events that could impact the Australian dollar and riskier assets like stocks are China’s upcoming trade numbers over the weekend and the inflation stats on Wednesday. The focus will probably fall on producer prices, which are expected to have accelerated to 12% in October from 10.7% previously on a yearly basis. 

This metric will be crucial in settling the raging inflation debate. If Chinese factories keep exporting inflation abroad at an accelerating pace, it’s another factor arguing for persistent inflationary pressures. 

Chart

And finally in the United Kingdom, the GDP stats for September and the entire third quarter will hit the markets on Thursday. The Bank of England took markets by storm this week after it held its fire on raising interest rates, sinking the pound. That said, investors remain confident this was only a delay, pricing in aggressive rate hikes over the next year. 

As such, the risks surrounding the pound remain tilted to the downside. The UK economy is not overheating to the point where it needs dramatically higher rates. The BoE simply wants to keep inflation expectations in check, something it can achieve with far less tightening than what’s currently priced in. 

Forex trading and trading in other leveraged products involves a significant level of risk and is not suitable for all investors.

Feed news Join Telegram

Recommended Content


Recommended Content

Editors’ Picks

EUR/USD struggles to gather momentum, stays near 1.0350

EUR/USD struggles to gather momentum, stays near 1.0350

EUR/USD is having a difficult time gathering bullish momentum and fluctuating at around 1.0350 in the American session. With Wall Street's main indexes pushing lower after the opening bell, the US Dollar is gathering strength and not allowing the pair to gain traction.

EUR/USD News

GBP/USD falls below 1.2000 as mood sours

GBP/USD falls below 1.2000 as mood sours

GBP/USD has turned south and declined below 1.2000 in the second half of the day on Tuesday. The negative shift witnessed in risk sentiment seems to be helping the US Dollar find demand and forcing the pair to stay on the back foot.

GBPUSD News

Gold retreats to $1,750 area as US yields edge higher

Gold retreats to $1,750 area as US yields edge higher

Gold price lost its traction during the American trading hours and retreated to the $1,750 area. The benchmark 10-year US Treasury bond yield is up 1% on the day slightly above 3.7%, not allowing XAU/USD to build on earlier gains.

Gold News

Bitcoin price hears jingle bells rolling in

Bitcoin price hears jingle bells rolling in

Bitcoin price looks set to rally substantially higher now that the social unrest in China is calming down. BTC could stage a 17% rally in the coming week.

Read more

Alibaba shares advance 5% on reduced China covid restrictions

Alibaba shares advance 5% on reduced China covid restrictions

BABA stock has jumped more than 5.2% in Tuesday’s premarket to $80 after China's National Health Commission said covid-related lockdowns should end as soon as possible. 

Read more

Majors

Cryptocurrencies

Signatures