US Inflation Hits Four Decade High, Yet Greenback Holds Strong on Rate Hike Expectations

Inflation in the US has surged to its highest level in more than four decades, yet the greenback has continued to remain robust as markets anticipate aggressive monetary tightening by the Federal Reserve.

In March US consumer prices surged 8.5% compared to the same period last year, according to figures released by the US Labor Department on Tuesday. The reading marks the biggest inflation rise since December 1981.

Year-on-year (YoY) inflation has accelerated steadily since the start of 2022, with the US consumer price index (CPI) up 7.5% YoY in January, before lifting to 7.9% YoY in February.

The White House said that military conflict in Ukraine and global supply chain disruptions are the key factors behind the rapid gains in prices.

Other sources of economic opinion also point to the effects of the loose fiscal and monetary policies implemented to ameliorate the impacts of the COVID-19 pandemic.

Despite the US seeing breakneck inflation since the start of the year, the dollar index has continued to post a strong performance, breaching the 100 point threshold to tap its highest level in nearly two years on Tuesday.

The US dollar index is set to enter its fourth consecutive quarter of increase, reflecting its rising strength compared to basket of 6 key currencies including the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc.

The strong performance of the US dollar against other major currencies is likely due to market expectations of aggressive tightening in monetary policy by the Fed this year. Each successive reading of untamed inflation gives further impetus to market anticipation of strong rate hikes.

In March the the Fed raised its target rate by 25 basis points, for the first increase since December 2018. Fed officials have since given strong indications that a succession of further rate hikes are incoming.

On Tuesday US Federal Reserve governor Lael Brainard spoke of the need for the central bank to deal “expeditiously” with the problem of raging inflation.

Brainard said that driving inflation back down to the target rate of 2% is now “the most important task” for the Fed, in an interview published by the Wall Street Journal.

These comment were far more hawkish than previously anticipated, particularly given the moderate tenor of Brainard’s statements in the past.

Federal Reserve chair Jerome Powell has also made remarks indicating that future interest rate hikes will in larger increments than usual, in order to ensure that borrowing costs rise fast enough to stymie inflation.

Economists polled by Reuters at the start of April expect two back-to-back half-point hikes in interest rates in the months of May and June, given the Fed’s determination to firmly curb inflation.

These market expectations of further rate hikes in the next few months are keeping the US dollar buoyant, even as the purchasing power of the greenback declines and the real wages of American workers contract.

Further appreciation of the greenback may prove to be challenging however, given that tighter monetary policy has been fully priced in, with money markets already anticipating 221 basis points in rate hikes by December.