The U.S. dollar traded sharply higher on Tuesday against all of the major currencies on the back of red-hot consumer price growth. CPI rose 0.9% in the month of June, up from 0.6% in May and against a 0.5% forecast. On an annualized basis, consumer price inflation jumped 5.4%, the largest increase in 12 years. Core prices rose 4.5%, the fastest rate since 1991. While everyone expected price pressures to increase, today’s report illustrates how significant the problem has become. Not only are prices rising sharply, but the increases are more widespread, which means prices can remain high for longer. This is particularly likely given that large parts of the problem are supply chain issues that are not easy fixes.
While today’s CPI report casts doubt on the Federal Reserve’s view that high inflation is transitory, the inconsistent performance of stocks and bonds are a sign that investors are still undecided. Fed fund futures are pricing in a 90% chance of a rate hike in December 2022, but 10-year Treasury bond yields ended the day lower and not higher. Stocks fell, but the decline was modest. Investors are clearly waiting for guidance from Fed Chairman Jerome Powell, who delivers his semi-annual testimony on monetary policy and the economy tomorrow. The U.S. dollar will give back gains if he downplays CPI. But if he suggests that taper is right around the corner, the dollar could extend higher quickly.
Policy adjustments will be the main focus on Wednesday. The Reserve Bank of New Zealand and the Bank of Canada meet before Powell’s testimony. Both currencies sold off on U.S. dollar gains despite the prospect of less dovishness. The RBNZ and the BoC are two of the most hawkish central banks. No changes are expected from the RBNZ this month, but it is widely expected to be the first major central bank to raise interest rates. A number of local banks are calling for a rate hike in November, which means they could signal this intention as early as this month. The subdued performance of the New Zealand dollar suggests that investors are not positioned for hawkish forward guidance partly because of COVID lockdowns in Australia and slowing Chinese growth. Yet, the misalignment between NZD price action and RBNZ guidance could translate into big moves for the New Zealand dollar. If .6920 is broken, the next support will be 68 cents. On the upside, the next stop above .7025 should be .7150.
There’s about an 80% chance the Bank of Canada will reduce asset purchases on Wednesday. It kicked off the global taper cycle back in April, and is widely expected to continue normalizing monetary policy with inflation above target and growth accelerating. Nearly 68% of Canada’s population has received at least one COVID-19 vaccination dose, allowing the country to ease restrictions. This has been accompanied by stronger job growth and manufacturing activity. In the central bank’s latest quarterly Business Outlook Survey, the sentiment index rose to a record high as executives anticipate a burst of demand.
Like the New Zealand dollar, there have been no meaningful gains for the Canadian dollar despite the likelihood of less dovishness. While it can be argued that investors have priced this in, there’s little chance of USD/CAD escaping big moves on Wednesday. This misalignment between market expectations and the loonie almost assures that USD/CAD breaks 1.26 or tests 1.24 before the end of the week.
The euro and sterling sold off against the U.S. dollar, but it is the British pound that will be in focus tomorrow. U.K. inflation data is scheduled for release, and like the U.S., stronger price pressures are expected for the month of June. However, given an imminent lack of rate decision EUR/USD and GBP/USD will most likely take their cue from the market’s demand for U.S. dollars.