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Dollar break-out

By David Morrison  |  02/05/2018 08:12

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This article looks at the US dollar. It now looks as if last year’s weak dollar trend is over thanks to a sharp pick-up in US inflation

Early last week the dollar broke out of several trading ranges which had been establishing themselves since the end of January. This saw the Dollar Index push above 90.00 and the EURUSD fall below 1.2200. Initially there was speculation that these could be false breakouts and that the weak dollar trend that ran throughout 2017 would soon re-establish itself. However, last week’s move (which coincided with a sharp rally in US bond yields) continued Monday and accelerated in yesterday’s trade, helped to some extent by low volumes thanks to the May Day break across Europe. Now there’s a plethora of analysis suggesting that the dollar rally is set to continue as US economic growth and inflation pick up sharply while those of the Euro zone, Japan and the UK effectively flatline.

On Monday, the Fed’s preferred inflation measure, Core PCE, rose 1.9% year-on-year to hit its highest level since the summer of 2012. This was well above the 1.6% recorded for the previous month and means that US inflation is now within a whisker of hitting the Fed’s 2% target. The news came just ahead of a two-day Fed meeting which ends this evening. The Fed isn’t expected to hike rates. For a start this isn’t a major quarterly meeting with an accompanying set of FOMC economic projections. Also, first quarter GDP growth, while a respectable 2.3% annualised, fell back from the 2.9% recorded in the fourth quarter. Nevertheless, the PCE number wasn’t the first indication that inflation is picking up in the US. After all, it was an unexpected jump in Average Earnings which contributed to the sell-off in equities in early February. While this subsequently reversed, the unemployment rate is hovering around 4.0%, its lowest level in 17 years suggesting that upside pressure on wages can’t be far away. Yesterday afternoon the ISM Manufacturing Prices survey hit its highest level in 7 years. Putting this together, the feeling is that tonight’s FOMC statement may indicate that the central bank is waking up to the prospect of higher inflation, increasing the probability of a further three 25 basis point rate hikes this year.

On Friday we have the Non-Farm Payroll and Average Hourly Earnings update for April. The consensus forecast is for payrolls to bounce back towards 200,000 following last month’s dismal number of 103,000. The Unemployment Rate is expected to dip to 4.0% from 4.1%. However, the participation rate is still very low which means large numbers of Americans have given up looking for work and consequently don’t count as unemployed. Some analysts feel that these discouraged workers should soon come back to the jobs market given the low level of unemployment nationally. This should keep a cap on wage growth and consequently not add to inflation. But others argue that these workers may never come back into the labour market as they lack the skills required by many modern businesses. On top of this oil prices have risen steadily since last summer. While these won’t show up in core inflation numbers, they add costs to consumers and corporations alike.

Meanwhile, last week brought the release of a disappointing first quarter UK GDP number. This has seen the probability of a 25-basis point rate hike from the Bank of England this month plunge to 20% from 90%.  Add in the problems currently faced by Theresa May’s government, particularly following the House of Lords vote on the EU Withdrawal Bill, and it’s no wonder that cable has broken below the lower end of the trend channel that has held since the beginning of last year. If the GBPUSD can’t break back above here over the rest of this week, then it would present further evidence to suggest that the ‘weak dollar’ trend is over for now.

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Any information, analysis, opinion, commentary or research-based material on this page is for information purposes only and is not, in any circumstances, intended to be an offer of, or solicitation for, a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. Any person acting on it does so entirely at their own risk and GKFX accepts no responsibility for any adverse trading decisions. You should seek independent advice if you do not understand the associated risks.
 

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