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Increasingly higher inflation prints from the US may harm rather than prop up the US dollar index (DXY).

A big beat on January CPI is needed

Increasingly higher inflation prints from the US my harm rather than prop up the US dollar index (DXY). The median consensus is already calling for a 7.3% y/y print with a narrow forecast range of 7.0%-7.6% y/y, versus a 7% print for December, according to a recent poll by Bloomberg. Granted, this is high by any measure, but on a month-to-month basis, headline inflation has been decelerating since November 2021.

Is the inflation narrative dead?

Even a consensus print could put downward pressure on the DXY. Rising inflation has been the dominate theme that has lifted Fed rate hikes expectations, and in turn helped lift the DXY. Interest rate markets imply four to five hikes in 2022, followed by potentially two or three more in 2023. A consensus CPI number or a miss has the potential to cause some of those interest rate expectations to unwind.

Attention could turn to growth

Death of the inflation story could quickly shift the market narrative away from inflation and firmly on growth. The International Monetary Fund’s World Economic Outlook points to US economic activity slowing from 5.7% last year to 4.0% in 2022. Furthermore, more timely indicators like the ISM January manufacturing and non-manufacturing indices show a slower pace of activity in January.

Labour market conditions, on the other hand, have held up as indicated by January’s strong labour market report. That said, the US labour cost index fell to 1%y/y in Q4 last year vs 1.3% y/y in Q3, casting doubts about a wage-price spiral. In addition, labour market participation, especially in certain sectors, remains depressed compared to pre-pandemic levels.

Technicals don’t look bullish

Likewise, the technical picture for the DXY doesn’t exactly exude confidence about the US dollar. After the big surge in the DXY in November 2021, the index failed a sustained break above the 96.940 95.495 range that has more or less held up since the end of December. More recently, the index has tested and been hugging the bottom of that range. RSI and the 200-day exponential moving average, also tell a less than bullish story.

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The dollar index edges lower on Wednesday after rebound on better than expected US NFP showed signs of stall.

Repeated failure to clear initial Fibo resistance at 95.66 (23.6% of 97.42/95.12 bear-leg) weakened near-term structure, as daily MA’s (10/20/55) remain in negative setup and 14-d momentum stays in the negative territory.

The action, however, remains underpinned by 100DMA (95.24) and the base of thick daily cloud (95.08), but renewed attack at these supports cannot be ruled out.

Violation of these levels would signal an end of limited corrective phase of larger downtrend from 97.42 (2022 high).

Bullish scenario requires firm break of 95.66 Fibo barrier to generate initial bullish signal, which would look for confirmation on extension through 96.00/10 pivots (daily Kijun-sen / cloud top).

The action is likely to stay in a quiet mode ahead of key release of this week – US inflation, which is expected to generate stronger direction signals.

The price pressure is expected to rise further in January as forecasts see annualized inflation rising to 7.3% from 7.0% previous month that would increase pressure on the US central bank which has already penciled a rate hike in March and signaled three-to four further hikes this year.

The greenback may accelerate on inflation data beat as this would signal that Fed’s view of transitory process is no more valid and prompt a stronger action from the central bank.

Res: 95.73; 96.00; 96.10; 96.27
Sup: 95.24; 95.08; 94.87; 94.59

US commercial crude oil inventories dropped -4.8m barrels in the week ending February 4. At 410.4m barrels, oil inventories are about -11% below the give year average for this time of year.

Gasoline inventories dropped -1.6m barrels. Distillate dropped -0.9m barrels. Propane/propylene dropped -1.9m barrels. Total commercial petroleum inventories dropped -8.1m barrels.

WTI crude oil recovers today after drawing support from 4 hour 55 EMA and near term channel support. It's now back above 90 handle. Near term outlook stays bullish for now. Current rise from 62.90 is still in progress and break of 93.52 will target 61.8% projection of 82.42 to 93.52 from 88.66 at 95.51 next.

In a Twitter Q&A, ECB Executive Board member Isabel Schnabel said, "in the 1970s rising oil prices triggered a harmful price-wage spiral, as inflation expectations drifted away." But, "today longer-term inflation expectations are well-anchored. We will ensure that high inflation does not become entrenched."

"Inflation will remain high for longer than anticipated. There is a risk that inflation continues to rise in the near term but it is likely to gradually decline towards the end of this year. There remains high uncertainty around the inflation outlook."

"Raising rates would not lower energy prices. But if high current inflation threatens to lead to a de-anchoring of inflation expectations, we may still need to respond, as our mandate is to preserve price stability."

"Monetary policy has to keep a watchful eye on all factors, including energy, that affect the medium-term inflation outlook. An extended period of high energy price inflation may lead to expectations of higher inflation in the future."

The UK will publish its final quarterly GDP growth readings for 2021 on Friday at 09:30 GMT. The outcome may not impress investors as forecasts imply the economy almost flatlined at the end of the year, growing more or less at the same pace as in the previous quarter. Perhaps, the data could be considered outdated as well since the Bank of England has already taken its first steps to tackle the hot inflation pressures. Therefore, the British pound may not find enough support from domestic data to resume its ascent this week, but the figures could still act as a safety net against any selling interest.

UK GDP growth to stabilize in Q4, but does it matter? 

According to analysts, the UK economy expanded by 1.1% q/q in the last three months to December, exactly at the same rate as in the September quarter. The annual change may not light up fireworks either, as it is currently expected to moderate slightly to 6.5% y/y from 6.8% previously, approaching the normal pre-pandemic levels.

Undoubtedly, the above forecasts are still healthy and could bode well for the pound if materialized, especially as global supply chain disruptions and labor shortages are not expected to evaporate anytime soon. Yet, the data may not bring anything new to the table to adjust market sentiment.

The latest business Markit/CIPS PMI survey for January, although remaining within the expansion area, has already signalled a slower-than-expected positive start to the year, with the composite index barely improving from December. Details indicated that companies except those in the financial sector have raised their prices in an attempt to offset rising raw material costs, staff wages and energy bills, while some manufacturing companies faced their worst month in a year in terms of new orders. All in all, the survey’s respondents don’t expect any meaningful recovery before February.

Besides, with the Bank of England having already hiked its interest rates twice over the past two meetings to 0.50% and given the high probability for a third rate increase in mid-March, last year’s GDP stats could do little to change the status quo unless they surprise significantly to the downside; that is currently seen the least likely case since the government applied only mild restrictions during the end-of-year omicron breakout.

Traders bearish on pound; US CPI inflation in focus

Speculative net short positions for the pound have worsened a bit in February, almost tripling last week’s size but are still standing above January’s extremes, reflecting a bearish mood among traders despite the BoE’s hawkish stance. In the absence of any important news out of the UK, the British pound could remain exposed to the dollar's strength as the BoE and the Fed rate hike expectations increase in tandem. Particularly, Thursday’s US CPI Inflation readings for January could press pound/dollar below the nearby 1.3500 base and towards the 1.3435 support region if they call for a faster 50 bps Fed rate hike. A steeper downfall could bring the 1.3300 – 1.3355 zone next into view.

Otherwise, if US inflation falls short of analysts’ estimates, signalling that Fed rate projections are exaggerated, the pound could recoup the pullback off 1.3627. Yet only a close above 1.3700 and the 200-day simple moving average (SMA) could revive buying confidence in the market.

Markets

Trees don’t grow to sky. Even interest rate markets today took a breather as the combined effect of an ECB policy U-turn and strong US payrolls is apparently ‘discounted’. For now, it’s still nothing more than a pause, not a real correction, with tomorrow’s US inflation data a potential catalyst for further directional price action for bond markets. Central bankers’ comments don’t question the need for policy normalization, but don’t feel the need to push markets even further either. BoE’s chief economist Pill doesn’t rule out 50 bps steps but for now advocates a step-by-step approach as the outlook for wages and energy prices is highly uncertain. ECB’s Nagel confirmed that the ECB needs to recalibrate monetary policy in March if the inflation picture and above all the inflation outlook hasn’t significantly brightened by then. This shouldn’t be new for markets. At the same time, Nagel also warned for the risks/side effects of asset purchase programs. The jury on this topic is still out, but any (substantial) steps on the ECB reducing its balance sheet probably aren’t discounted by markets yet. Fed Bostic is still balanced between 3 and 4 rate hikes this year. He hopes for a gradual decline in M/M inflation readings in the near future to bring the PCE deflator to 3.0% by the end of the year. Still, he doesn’t exclude a 50 bps hike if the data would signal it to be appropriate. Bostic also advocates a substantial reduction of the balance sheet starting as soon as possible as he sees a lot of excess liquidity that can be reduced without representing a significant tightening. As indicated, today comments didn’t change the broader picture on policy normalization but didn’t prevent a limited countermove. US yields are developing between little changed (2-y) and easing 2.5 bps (10-y). This evening the US Treasury will sell $ 37 bln of 10-y Notes. On European interest rate markets the steepening trend continues, this time with the short end taking the lead. The German 2/5-y yields are easing 4.5 bps. The 30-y declines a more modest 0.75 bps. The relative calm on core bond markets for now brings only little relief for peripheral European bond markets with the 10-y Italian spread versus German easing no more than 2 bps. The pause in the bond market sell-off also revives some comfort among equity investors. European indices on average are rising about 1.75% (EuroStoxx). US indices continue yesterday’s comeback opening with gains of about 1.0%. (Brent) oil  ($91.1 p/b) stays off its recent peak, but for now with no follow-through price action.

Despite substantial moves on bond and equity markets, changes in the major FX cross rates mostly are limited. DXY index eases to 95.50. EUR/USD is holding north of 1.14 but at 1.1430 gains are negligeable. The risk-on for now still doesn’t help sterling (cf Pill comments?). EUR/GBP is going nowhere holding in the 0.8430 area.

News Headlines

UK Prime Minister Johnson has announced he’ll end this month the requirement for people in England to self-isolate if they test positive for the coronavirus. It’s part of the government’s “Living with Covid” strategy – to be announced February 21 – and it is subject to the continuation of currently declining Covid statistics. The self-isolation obligation was due to end on March 24. By shelving the rules earlier, Johnson hopes to amend tarnished support from Conservative lawmakers who have been calling for easing restrictions amid concerns over individual freedoms and the impact on businesses, schools and health service.

Mexican inflation eased less than hoped in January, from 7.36% y/y to 7.07% vs 7.01% expected. Core inflation, excluding a.o. fuel, even accelerated from 5.94% to 6.21%, the highest reading since 2001 and way above the 3% (+/- 1ppt) inflation target of the central bank (Banxico). Its new governor Victoria Rodriguez Ceja faces a difficult balancing act when the MPC meets for the first time this year tomorrow: tighten policy and tame inflation but risk hurting already stalling growth (-0.1% q/q in Q4 2021). Banxico started its hiking cycle in June 2021 and raised policy rates from 4% then to 5.50% today. Consensus expect another 50 bps increase tomorrow. The Mexican peso strengthens marginally today, from USD/MXN 20.61 to 20.55.

The Australian dollar has extended its rally for a third straight day. In the North American session, AUD/USD is trading at 0.7179, up 0.49% on the day. It’s looking all roses for the Aussie this week, which is up 1.49%.

The Australian government announced that it will reopen the international borders on February 21^st. The country hasn’t allowed any tourists in the country in two years, which has badly hurt the tourism sector. Visitors who are vaccinated will now be allowed entry, which should pump billions into Australia’s economy.

We are seeing a significant discrepancy in confidence levels between businesses and consumers. On Tuesday, NAB Business Confidence in February jumped 15 points to +3, after a miserable -12 reading in December. Consumers, on the other hand, did not share in the optimism. Westpac Consumer Sentiment for February declined 1.3%, marking a third straight drop. Covid health restrictions have eased and the labour market is strong, but this hasn’t boosted the mood amongst consumers. The likely culprits for the gloomy outlook are the continuing rise in the cost of living and financial pressures due to Covid and the possibility of higher interest rates this year.

In the US, surging inflation has become a major headache for Joe Biden as well as the Federal Reserve. Biden could face an angry backlash at the mid-term elections if gasoline and food prices continue to rise, and the Fed is hoping that a series of rate hikes will curb inflation back towards the 2% level, which seems like ancient history.

Those headaches could feel worse on Thursday, if inflation accelerates as expected. CPI hit 7.0% in December, and the consensus is for a gain of 7.3% for January. If inflation is within expectations or higher, the likelihood of a 50-basis point hike in March will increase. According to CME’s FedWatch, the markets have priced in a 75% chance of a 25-bps rise and a 25% chance of a 50-bps hike at the March meeting.

AUD/USD Technical

• AUD/USD continues to rally and is testing resistance at 0.7168. Above, there is resistance at 0.7258
• There is support at 0.6987 and 0.6896

Daily Pivots: (S1) 1.1392; (P) 1.1421; (R1) 1.1445; More...

Intraday bias in EUR/USD stays neutral and outlook is unchanged. A medium term bottom could be in place at 1.1120, on bullish convergence condition in daily MACD. Break of 1.1482 resistance will target 38.2% retracement of 1.2348 to 1.1120 at 1.1589 next. Sustained break there will argue that whole fall from 1.2348 has completed too and target 61.8% retracement at 1.1879. On the down, however, break of 1.1265 support will dampen this bullish view and bring retest of 1.1120 low instead.

In the bigger picture, the decline from 1.2348 (2021 high) is seen as a leg inside the range pattern from 1.2555 (2018 high). Sustained trading above 55 week EMA (now at 1.1613) will argue that it has completed and stronger rise would be seen back towards top of the range between 1.2348 and 1.2555. However, firm break of 1.0635 (2020 low) will raise the chance of long term down trend resumption and target a retest on 1.0339 (2017 low) next.

Daily Pivots: (S1) 0.9231; (P) 0.9247; (R1) 0.9268; More....

Intraday bias in USD/CHF remains neutral at this point. Further rise will remain mildly in favor as long as 0.9090 support holds. break of 0.9372 will resume the choppy rally from 0.8925 to 0.9471 high. However, break of 0.9090 will turn bias back to the downside for 0.8925 support instead.

In the bigger picture, medium term outlook will be neutral at best as long as 0.9471 resistance holds. Larger down trend could still extend through 0.8756 (2021 low). However, firm break of 0.9471 will argue that the trend has already reversed and rebound the rally from 0.8756 with another impulsive move.