Swissquote Bank: Inflation has become the major highlight

Swissquote Bank: Inflation has become the major highlight

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By Ipek Ozkardeskaya, Senior Analyst at Swissquote Bank| 

The major data highlight of today is the US inflation data. Inflation has become the major highlight of the last couple of months since consumer prices began picking up some solid momentum due to pandemic and post-pandemic-related factors including recovery and overshoot in oil and commodity prices, slow global logistics, global production shortages that led to a rapid rise in factory gate prices and fast-recovering wages.

Released at Wednesday, the Chinese inflation data printed a 9% jump in factory-gate prices. Add the ultra-expansive monetary and fiscal policies to the mix, and you have a large range of why we are where we are today in terms of inflation.

Today’s US inflation data is expected to reveal a figure close to 5%, which is a level that has not been seen since 2008, in the wake of subprime crisis, yet the figure per se will unlikely give cold feet to investors, as inflation expectations began easing nowadays.

In fact, inflation is not seen overshooting more than what we will see at today’s release. At least, this is what the activity and appetite in US treasuries tell us. Inflation is seen peaking in May, or maybe in June, but then it should stabilize and ideally soften without threatening the Federal Reserve’s (Fed) policy target of the average 2%. Hence, the Fed won’t pull away from its ultra-supportive monetary policy too early and the rally in equities could carry on.

But one last thing. Many say inflation should peak and fall shortly, but little say why and how it would, given that the inflation-boosting factors remain on the same boosting trend.

Investor appetite is muted before the most expected US inflation data. A stronger-than-expected inflation read would already be too strong, and should revive the Fed hawks and trigger a certain sell-off across the equity space regardless of the consensus view that today’s print should be the peak of the actual rising inflation cycle. A softer-than-expected figure, on the other hand, should strengthen the conviction, and the case for softening inflationary pressures and leave the Fed doves alone for at least another month.

Now another place which sees an impressive inflation rise is the Eurozone, where the flash estimate showed an advance to 2% in May, the highest since the last quarter of 2018. If the inflation situation in Europe is not as dramatic as in the US, those are quite unusual waters for the Eurozone. Still, the European Central Bank (ECB) will certainly not move an inch regarding its ultra-supportive monetary policy at today’s meeting. European businesses need support, and the ECB is here to provide them the support they need.

In the FX, the single currency had a toppish formation near the 1.2260 against the US dollar. But what the US dollar does is more important than what the euro does in this equation. Easing inflation could dent the US dollar appreciation and let the EURUSD run toward the 1.2350 region in the medium run. This is the base case scenario due to the base case expectation of easing US inflation.

But if we don’t see a U-turn in US inflation figures shortly, then there will only be a stronger case for a stronger US dollar globally, and a stronger dollar should send the EURUSD sustainably below the 1.20 level in the second half of the year.