The overwhelmingly positive surprise of June’s US inflation data sent financial market expectations soaring that the Federal Reserve was very close to ending its rate hikes.
While investors rejoiced and risk assets soared, US rates fell sharply, expectations of hikes beyond July were ruled out, and the dollar lost ground against all major world currencies.
The market reaction to the inflation news was entirely understandable. But we wonder if the dollar did not fall too quickly.
Table of Contents
The euro
The news about disinflation in the US sent the euro soaring and the common currency sharply out of the range it had held for most of 2023.
The move is understandable and in line with our forecasts, but the gloom over European growth could create headwinds in the short term.
The euro may find it difficult to rally due to the pulled market positioning until the state of the eurozone economy is clarified and pessimistic PMI survey numbers are confirmed or disproved by hard economic data.
The dollar
The June inflation report confirmed that US inflation is slowly but clearly on the right track. Inflation came in below expectations in both the headline and core index.
And the three-month average has now fallen to 4% year-on-year. The Fed is still likely to hike again in July, as it has already pledged to do.
However, any further hike would require significant upside surprises in the data on inflation and economic activity, which are unlikely.
As the end of the Fed’s hike cycle approaches, the scenario becomes more favourable for our basic view that emerging market currencies still have room for growth.
The pound sterling
The pound rose against the dollar last week, in line with all world currencies, although it lagged a little behind the euro. High interest rates and better than expected data continued to support the pound.
May GDP exceeded expectations despite the negative impact of the Coronation Day.
Markets expect a decline in the headline figure and stability in the core index, which should be consistent with another 50 basis point rise after the Bank of England meeting and continued strength in sterling.
Read also: Exploring the top 4 currencies for trading in Forex
