Forex Focus: Poor CPI causes US dollar slide
Stocks extended a rally on August 11 following softer-than-expected US inflation data. Despite poor US Consumer Price Index (CPI) readings, many believe it’s a sign of slower interest-rate hikes.
Overall markets soared on news of US inflation. The tech sector pushed a 1% climb in Asian equities while US and European futures rose after the S&P 500 reached a three-month high. The Nasdaq 100 pulled 20% above a June 2022 low.
The US dollar index has nosedived due to a poor CPI report. As the US deals with ever-increasing costs of goods and services, its consumers are far more reluctant to spend their earnings. This has the knock-on effect of curbing economic growth.
Many analysts, however, believe the Federal Reserve could pivot to a slower pace of rate hikes but that it’s still a long way from achieving its goal.
Forex – USD slides
The EUR/USD rose above 1.0300 due to fresh weakness in the US dollar. Poor risk sentiment is affecting the US as well as China’s ongoing COVID-19 woes.
Global investors are reassessing US inflation data and its effect on Fed rate hike expectations for the remainder of 2022. By midmorning on August 11, the EUR/USD pair had declined to nearly 1.2850.
All eyes on US inflation
Traders will need to keep an eye on the upcoming US Michigan Consumer Sentiment Index (CSI) data, due on August 12. Market consensus shows sentiment is higher at 52.2 from its prior reading of 51.5. It’s hoped that a consecutive improvement will boost consumer confidence. Earlier in 2022, the CSI dropped to 50 for the first time in 20 years.
US headline inflation was 8.5% in July, down from 9.1% in June (the largest in four decades) and a good sign for investors. Price hikes across many staples such as fuel are still high and the Fed reports that more rate hikes will be implemented. Alarmingly, the Fed said investors should rethink expectations of rate cuts in 2023.
Eurozone – War and gas crisis
In Europe, German inflation was 8.5% despite a big decline in oil prices. High inflation has created havoc for the European Central Bank. Unlike the Fed, hiking interest rates is much harder for the ECB as it faces many debt-burdened countries in the Eurozone.
Then there’s the ongoing war in Ukraine. Russia’s continued invasion is playing havoc with supply chains, mainly wheat and natural gas. The key natural gas pipeline between Germany and Russia is under threat and overall, prices for LPG have exploded in 2022.
Top Forex trading questions answered
Fred Razak, CMTrading’s Senior Trading Specialist, shares his trading trends for the rest of 2022:
Q: How have interest rates affected the USD?
Razak said: “Interest rates predominantly control the money in the market. If it costs more money to borrow then there’s going to be less supply of money. Fewer people are going to be incentivised to borrow money when interest rates are higher. The Fed is slowly adding interest rates that will slowly increase interest rates.
“That means fewer and fewer loans are going to be happening in the marketplace. This is done to control inflation; it controls the devaluation of the money. So that’s basically how rates affect the US dollar directly. Now how does that affect the rest of the world? Fewer US dollars in the market means a stronger dollar, and that’s how the Euro will have pressure on it, as interest rates are going to be increased and there’s going to be more valuable to the dollar.
What does the July CPI mean for currencies?
Razak said: “So CPI has become one of the most important numbers of the month, probably just as important as the FOMC rate decision and also the Non-farm payroll.
“CPI is a monthly inflation report where they take a bunch of consumer products and they put them together and see how the devaluation or how the inflation has affected the US dollar. Over the past year, we’ve seen a significant rise in inflation. We haven’t seen this historically in the US dollar. Now there are certain countries that right now going through some severe situation in the devaluation of their currency including the South African Rand and Turkish lira.
“Central banks are not keen on having a very weak currency but at the same time not giving it too much strength thereby causing the opposite of inflation, which is hyperinflation. So we try to keep it at a balance so that it doesn’t get too far.
Will interest rate hikes continue – what will their effect be?
Razak said: “Interest rates will continue until there’s a good CPI and the devaluing of currency doesn’t continue. So that is something that everybody is keeping a very sharp eye on. I think the Fed is very much aware that this is something that is a balancing act between inflation and the strengthening dollar. What stalls business growth is if loans are going to be more expensive. People are going to be less inclined to make loans or take out loans.
“This means businesses are going to pull back and make cutbacks such as closures and job cuts. This is like a circle, a balancing act so that there should be some sort of equilibrium in the market when we get into these types of situations.
Q: What’s going on with the Euro?
Razak said: “The euro is hovering near its lows. I mean it bounced off 1-to-1 versus the dollar by 200 PIPS, but that’s, you know relatively to its session lows. I mean you know we’re just 200 pips away from yearly lows of 1-for-1 to the dollar.
“We also can’t forget we have a war in Ukraine with Russia. So that’s something that’s lingering in the back of the minds of European traders and firms. In September and October, we will be hoping that some sort of plan between Germany and Russia will resolve the natural gas line crisis. If this doesn’t get resolved and the war continues, we can assume that Europe will have a serious situation to deal with in its summer.
Q: Thoughts on Asian currency pairs?
Razak said: “The Japanese yen has been steadily rising versus the US dollar just because it’s a steady economy. It’s not growing too fast, but it’s not devaluing too much either. So, it’s remaining strong versus the US dollar at its current levels and one to watch in Asia.
Q: How can traders take advantage of CPI numbers?
Razak said: “So the markets react quite adversely to CPI numbers and they’re very sensitive to this data. This is something to consider really, just understand the inflation report. The CPI figures showed poor consumer sentiment so there’s going to be more selling pressure on the Dow Jones and/or the NASDAQ, which are the major indices in the United States.
“So this is something to consider as we’re going into the end of the Northern hemisphere summer into fall, which is a very, very important period for markets.”