US month-on-month CPI data released yesterday showed inflation rising to a record annualized rate, exceeding expectations. Will the Fed be forced into earlier monetary tightening, and what might that mean for the U.S. Dollar and stocks?
Yesterday’s release of June’s US CPI data revealed that annualized inflation has jumped from 5% the previous month to 5.4% in June, which is the highest rate it has reached for 13 years. The consensus forecast before the release was expecting an annualized rate of only 4.9%. The real data exceeded expectations for the second month in a row, which is significant in building a sense that inflation in the US is getting somewhat out of control.
Another alarming factor was that the monthly increase in the CPI was the biggest seen since 2008.
What is Behind the Rise in US CPI?
The CPI is calculated from the price changes in a basket of goods and services, weighted to reflect a representative sample that would be purchased by a wide cross section of the population in everyday life. Analysts like to drill down to see which sectors were most responsible for the overall change in the CPI to try to understand what is driving the change.
Clearly, the rebound from the initial shock of the coronavirus pandemic in March 2020 is responsible for most of the rise, giving hope to those analysts and the Federal Reserve who maintain that the increase is essentially transitory. Interestingly, most of the increase seems to have been generated by travel-related items, especially used cars.
Will the High CPI Impact the Fed’s Policy?
The Federal Reserve, like many other central banks, is artificially propping up the stock market by spending huge amounts of money purchasing stocks. It sounds ridiculous when put so plainly, but this is the situation. It is effectively printing money, and printing money can lead to higher inflation. So, when inflation is seen as getting higher and higher and possibly out of control, it will place pressure on the Fed to “taper” earlier than had been planned. All else being equal, this should lead to lower stock prices and a higher relative value in the US Dollar.
It will be interesting to see how the Fed handles this data print. An early hint will come later today and tomorrow when Jerome Powell, the Chair of the Federal Reserve, testifies before the US Congress.
The Biden administration effectively played down the rise, portraying it as due to a transitory issue arising from the coronavirus rebound.
What Does This Mean for Traders?
Forex traders should be aware that the U.S. Dollar is the most important currency in the Forex market, and that big swings in value over recent decades have been driven by the USD more than any other currency. So, anything affecting fundamentals and sentiment on the greenback is worth watching.
If the Fed begins to hint again at bringing forward tapering and expected rate hikes, it could increase the value of the USD and kick-start the long-term bullish trend in the greenback which has recently stalled. So, traders should watch comments from the Fed carefully.
Technically, it makes sense to watch and see if the USDX (US Dollar Index) can get established above the key resistance level at 11926. If it does, that will be a bullish sign that could be worth buying.
However, it is worth noting that the U.S. Dollar Index has fallen since yesterday’s CPI data release, and the main U.S. stock index the S&P 500 is just shy of its all-time high price at the time of writing, so it does not look as if the market is ready to move decisively in favour of the greenback just yet.