Swissquote Bank: Is it finally time for softer US inflation?

Swissquote Bank: Is it finally time for softer US inflation?

Inflation Outlook
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By Ipek Ozkardeskaya, Senior Analyst at Swissquote Bank

Richard Branson was not the only one flying to the sky recently. The S&P 500 and Nasdaq progressed through uncharted territories, as well. Financial and real estate stocks pushed the S&P 500 to an all-time high, while Nasdaq was boosted by Tesla, which gained more than 4%.

At Monday, although the latest news was mostly about Elon Musk being at court to defend its 2016 SolarCity acquisition.

Today, investors will be closely watching the US inflation data. Inflation in the US shot up to 5% in May, as a result of more than 50% rise in energy prices, the jump in second-hand car prices, and of course, the Federal Reserve’s (Fed) ultra-supportive monetary policy. And for the Fed policy to stay this supportive, we need to see at least some slowdown in the inflation figures at today’s print.

The headline inflation in the US is expected to have eased to 4.9% in June, from 5% printed a month earlier. Although the figure will be relatively strong compared with the Fed’s 2% inflation goal, any softening will likely bring the ‘transitory inflation’ rhetoric back on table and should further pressure the yields to the south, and the equity prices to the north.

A print above the 5% mark, however, will likely revive the worries that inflation may not fade as rapidly as the US policymakers first thought, and should, in theory, boost appetite in stocks of businesses which could more easily pass the rising material costs on to their clients.

In the FX, a softer-than-expected US inflation should lead to a softer US dollar as well, yet the dovish shift from the European Central Bank (ECB) should remain the main catalyzer on the EURUSD. Any advance driven by strong dollar could be interesting top selling opportunity for the euro bears looking for a further slide in EURUSD into next week’s ECB meeting.

In commodities, gold will likely remain offered near and above the $1 800 per oz, given that risky trades remain too appetizing for investors to sit on non-interest-bearing gold.

What will happen to the euro-franc? The franc appreciated meaningfully since the ECB pulled its inflation target to 2% and said it would allow some overshoot above this level. The EURCHF tanking a figure in a single session. The globally weakening euro is bad for Switzerland which is fighting so hard against a stronger franc.

Therefore, the Swiss National Bank (SNB) will likely continue fighting against the franc appreciation through FX interventions, as there is little chance to see the SNB moving more dovish on its own monetary policy by pulling the rates lower.

The Swiss benchmark rate is already at -0.75% and lower interest rates won’t encourage investors to divest from franc, as the motivation to enter and to hold the Swiss franc is not necessarily financial, it’s mostly seeking a refuge.

Moving forward, we could see some paradox in SNB policy. Inflation will also become a problem for Switzerland. The best remedy to rising inflation is a strong currency. Yet, the SNB will do its best to keep the franc as soft as possible to prevent any further damage on already expensive Swiss exports to the rest of the world. In this respect, the SNB can only keep its rates steady, buy more euros and hope that a new wave of market turmoil wouldn’t increase inflows to its beloved Swiss franc.

In the short run, given that the first appreciation shock is behind, the EURCHF should recover toward the 1.09 mark. But in the longer run, a globally softer euro can only weigh on EURCHF, which should further slide and settle within the 1.0750/1.0850 region.

Against the US dollar, the expectation is a slow but steady US dollar appreciation, and a long-term USDCHF at 1.0, as the Fed would start unwinding its asset purchases and move towards a interest rate normalization.