US dollar soars as inflation fears slam markets

Risk assets worldwide endured a very difficult week.

Inflation data continues to get worse and central banks are sounding increasingly strident alarms over the need to bring it down. Interest rates blew out worldwide; interestingly, this time European rates rose further than US ones, in response to a decidedly hawkish ECB. Somewhat ominously, European peripheral rates rose most of all. Amid the stock market sell-offs, the US dollar regained its status as the safe-haven of choice for investors, and rose against every single major currency worldwide.

The Federal Reserve meeting next week will be the event to watch in currency markets. In the wake of Friday's nasty inflation numbers in the US, markets are pricing in a 25% chance of a 75bp increase. The Bank of England meeting will also be a nail biter, with markets evenly split between expectations for 25 and 50 basis point hikes. Everywhere central banks are gearing up for the war on inflation, and the speed at which rates rise in different regions will be the main driver of currency moves in the near and medium term.


Sterling traded quite well last week. It fell against the dollar, but rose against every other G10 currency, in a sign that the market may already be very short the pound and, at current levels, a lot of bad news is already priced in. An unusually large positive revision to the PMIs of business activity for May also helped, suggesting that the Bank of England negativity on the UK economy may be overdone.

This Thursday we expect a 25 basis point interest rate hike, but there should be enough hawkish dissent

among Monetary Policy Committee members, calling for a 50 basis point hike instead, to provide support

for the pound.


The May ECB meeting last week proved that its hawkish pivot is gathering momentum. It announced that purchases of sovereign bonds will end 1st July and, most critically, it took the highly unusual step of pre-committing to a 25bp hike in July and a 50bp one in September. In addition to high inflation, the ECB now has to worry about peripheral spreads, which blew out significantly last week. However, in historical terms peripheral yields remain fairly low, and the central bank signalled that for now at least the inflation battle takes priority.

This week there is no market moving news on tap out of the Eurozone, so the focus will remain across the Atlantic on the Federal Reserve June meeting.


Friday's inflation data out of the US was unambiguously bad news for the Federal Reserve. The headline was another multi-decade high of 8.6%, dashing expectations that inflation had peaked a few months back. Core inflation also printed higher than expected, and price pressures are both accelerating and widespread. Particularly worrisome is the acceleration in housing inflation, which tends to be one of the most persistent components of the index.

The market's knee-jerk reaction was, perhaps understandably, to sell everything and buy the US dollar. It is now up to the Federal Reserve to validate the market's very high expectations. Even a 50 bp hike and a hawkish press conference may not be enough to sustain the dollar rally.


The Australian dollar, like all major currencies, depreciated against the US dollar last week. The hawkish surprise from the Reserve Bank of Australia, which raised rates by 50 basis points, as we had anticipated, was not enough to support AUD.

The RBA raised rates to 0.85% in response to soaring price pressure that the country is experiencing. This is the second rate hike since May designed to address the ‘significant increase’ in inflation, as justified by the RBA in its statement last Tuesday. However, despite the surprise, the announcement was not entirely hawkish. In the rate statement, it stressed that while ‘inflation is expected to rise further’, currently standing at 4.8%, ‘it will then decline toward the 2 to 3 percent range next year.’ RBA governor Lowe noted that ‘as global supply-side issues are resolved and commodity prices stabilise, inflation is expected to moderate, today's interest rate hike will help with the return of inflation to target over time’.

The May unemployment rate will be released on Friday. Aside from that, AUD will be driven by events elsewhere.

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