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The Dollar Rally Falters as US CPI Misses Expectations

Friday’s strong Nonfarm payrolls report lit a match under the US dollar last week. It all but confirmed the Fed could begin to taper their QE (quantitative Easing) programme in September and likely announce it later this month. Adding another 943k jobs to the economy in July (on top of +938k in June) whilst unemployment fell to a pandemic-low of 5.4% was cause for the celebration which resulted in the dollar’s surge. Yet with inflation softening, it sheds a little doubt for some Fed members as to whether they should taper, even if CPI does remains strong overall.

CPI may be down, but it’s not out

Core CPI rose just 0.3% in July, down from 0.9% in June and far below the 1.2% expected. This certainly plays into Jerome Powell’s view that ‘inflation is transitory’ and shed’s a little doubt as to whether the Fed will announce QE at this month’s Jackson Hole’s symposium.

However, despite the CPI miss overnight we continue to expect the Fed to announce QE at the Jackson Hole symposium and begin tapering their QE programme in September. Bottle necks remain in supply chains and this inflation report may simply be a ‘blip’, and there are signs of inflation building elsewhere.

Inflationary pressures are building elsewhere

The US has called for OPEC+ to increase oil supply, which is a good indication that higher oil prices are hurting the US consumer which itself is inflationary. The US Senate approved a US $3.5 trillion stimulus package this week, which serves as a strong reminder US fiscal policy continues to work in overdrive. The employment situation shows signs of improvement from the Nonfarm payroll report, and there are warnings that wage inflation could pick up. The NFIB small business survey shows that plans to increase employment and current job openings are at record highs (thanks to government handouts) and, if these jobs are not filled it puts upwards pressure on wages to coax people back to work. And that would be a tailwind for inflation as demand pics up.

Dollar set for a corrective phase?

Technically, US yields may be entering a corrective phase as both the 30 year and 10-year yields have found resistance around their 50 and 200-day eMA’s.  The 10-year rate fell -1.9 bps to 1.335% and formed a bearish outside day, and that is turn weighs on the US dollar.

USD/JPY rose to a 1-month high ahead of the report, in line with our bullish bias outlined in last week’s NFP preview. Given it closed back below the July 14th high and the pair is yet to retrace, a pause in trend or countertrend move appears plausible.  

EUR/USD broke a 6-day losing streak and printed bullish engulfing candle on the daily chart. A bullish reversal candle respected the March 2020 low, therefore a break above yesterday’s high assumes bullish continuation and brings 1.1800 into focus. However, given the likelihood that the Fed will announce tapering at the Jackson Hole symposium later this month and the ultra-dovish stance of the ECB, we currently view EUR/USD gains as a countertrend move which could eventually break to new lows.