Yen breakout: Global inflation bad for the buck

Figures showing hotter than anticipated US inflation in January produced, upon first glance, a surprising reaction in global markets. Higher US inflation, which by its nature should mean higher US interest rates led to a sell-off in the US dollar and a rally in stock markets. Less than a week earlier stock markets had collapsed and the dollar rallied over fears higher wages would produce higher inflation.

The most notable reaction was in the Japanese yen, which broke out of its long-term trading range to hit a 15-month high (15-month low for USDJPY).

Weekly candlestick chart for the Japanese yen

Japan

The US inflation data was accompanied by some particularly soft US retail sales figures. There is a sense now that higher consumer prices could kill off consumer spending and weigh on the US growth rebound. Slower growth would keep a lid on wage and overall price pressures. We do not see a notable ‘lift off’ in US growth, despite the tax cuts, so the Fed will probably will not deviate from the three hikes priced in by the market.

Global rate differentials explain a lot about why the dollar can’t find a bid, even when US inflation exceeds expectations. UK consumer prices growing faster than expected in January was a demonstration that inflation is picking up across the globe. We continue to believe the response to higher inflation and the removal of emergency stimulus from the other main global central banks means rate differentials with the US will converge rather than diverge. As the ECB, Bank of England & BOJ move closer to tightening policy, bund, gilt & JGB yields will rise faster than treasuries, making the euro, pound and yen more attractive than the dollar.

The current bout of dollar weakness could still stumble, particularly as EURUSD and GBPUSD approach multi-year peaks at 1.25 and 1.43 respectively. But the breakout in the yen skews the risks in favour of another leg lower in the buck.

This information has been prepared by London Capital Group Ltd (LCG). The material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. LCG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. Spread betting and CFD trading carry a high level of risk to your capital and can result in losses that exceed your initial deposit. They may not be suitable for everyone, so please ensure that you fully understand the risks involved.