Three reasons why higher US inflation figures may not help the USD – Commerzbank

Today, the foreign exchange market is awaiting the week's key data: the US inflation figures for May. Since the beginning of the pandemic, the reasoning has usually been straightforward: if inflation exceeds expectations, the Fed is expected to respond by raising interest rates, which has historically benefited the US Dollar (USD), Commerzbank's FX analyst Michael Pfister notes.

USD faces crucial test as US inflation data looms

"There is no guarantee that rising inflation risks will lead to a stronger USD. Using data from 2002 onwards, the lower charts show virtually no relationship. It may be that the relationship between rising inflation risks and a stronger USD only becomes apparent during periods when the Fed makes changes to its monetary policy, i.e. when it raises interest rates or delays cuts. However, it is also possible that inflation simply did not play such a significant role in the years leading up to the pandemic. In the 2010s, central banks tended to struggle with low inflation, meaning that it did not have as big an impact on the USD as it has recently."

"The USD can no longer benefit from rising inflation expectations, arguing that a temporary inflation shock would reduce the purchasing power of the USD, but would not necessarily prompt a response from the Fed. This could be an explanation as to why higher inflation could lead to a weaker USD. Ultimately, the risks to the market have shifted in recent weeks. It is not only the Fed that has recently warned that the risks to its two mandates are now more balanced. Following 'Liberation Day' and the announcement of unexpectedly high tariffs, the market also became increasingly concerned. This was less about the impact on inflation and more about the real economy. In such an environment, it is more difficult to link higher inflation to a stronger USD."

"Admittedly, these are medium-term arguments. Back to today's figures, our economists still assume that the tariffs did not have a noticeable impact on prices in May. However, this does not mean that this will also be the case in the coming months. These effects are taking longer to materialise than some had expected. This could convince some market participants that the recent stagflation concerns were exaggerated, which would support the USD. Nevertheless, I would not bet on this remaining the case."