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Why the dollar is selling off, despite strong US inflation

( 3 min. )

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18 May 2021

Written by
Matthew Ryan

Matthew Ryan is Ebury’s Global Head of Market Strategy, based in London, where he has been part of the strategy team since 2014. He provides fundamental FX analysis for a wide range of G10 and emerging market currencies.

The dollar sank to fresh lows versus its major peers on Tuesday morning as investors overlooked last week’s US inflation data and instead bet on ultra-low Federal Reserve rates for the foreseeable future.

W
ednesday’s much hotter-than-expected inflation print sent the dollar sharply higher against most currencies as traders began bringing forward their expectations for higher US rates. Since the end of last week the dollar has, however, been firmly on the back foot. EUR/USD has soared back above the 1.22 level for the first time since the end of February, with sterling also trading just shy of the 1.42 mark verus the greenback. While last week’s inflation data came in above consensus, the news has been slightly overshadowed by the recent underwhelming US payrolls and retail sales figures, both of which suggested that the country’s economic rebound may be stalling.

Moreover, Federal Reserve communications in the past few days have continued to reiterate that the bank will look through temporary spikes in inflation above the Fed’s 2% target. FOMC member Kaplan spoke on Monday, noting that he does not expect the Fed to start hiking rates until next year. The Fed is making it clear that one higher inflation print won’t be enough to materially change its view on policy and investors have subsequently calmed bets that higher rates could be on the way soon, triggering a move lower in US long-term yields and the dollar.

US dollar

Pound soars above $1.42 as investors bet on strong UK recovery

With the US recovery showing signs of easing, investors are now focusing on the expected rebound in activity elsewhere. The UK unwound virus restrictions again as scheduled on Monday, including the reopening of indoor hospitality and the easing of limitations on gatherings. Investors are betting on a strong rebound in growth in the UK in light of the country’s impressive vaccine rollout, with sterling just about the best performer in the G10 in the past 24 hours or so as a result – up over half a percent versus the dollar. Data out this week will provide a decent gauge as to the strength of the recovery thus far. We will be paying particularly close attention to Friday’s retail sales data for April and the business activity PMIs for May. The former will be particularly important, as it will be the first print to cover the period when high street retail outlets have been allowed to reopen.

The euro has also rallied sharply so far this morning as investors dump the greenback. While the vaccine rollout in Europe has lagged behind its major peers, an acceleration in the pace of daily vaccinations in recent weeks has provided reason for optimism, as has news of a gradual unwinding in virus restrictions in the bloc. Spain ended their curfew the weekend before last, France is moving its curfew from 7pm to 9pm and Italy said it would phase it’s one out over the coming week. These are much smaller steps to freedom than those taken in the US, but the situation is at least moving in the right direction and investors are optimistic that this will be reflected in stronger macroeconomic news out of the Euro Area in the coming weeks. A number of economic releases are scheduled out of the bloc this week. It is perhaps too soon to see any material rebound in hard data, but Friday’s PMIs are expected to continue their recent trend higher.

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