HomeU.S. Inflation Higher Than Expected, Weighs on the Dollar

U.S. Inflation Higher Than Expected, Weighs on the Dollar

Inflation increases in the United States, sending stocks higher and the greenback lower.

The most important piece of economic data for the week was released yesterday – the U.S. inflation for March. The data exceeded expectations, as many traders assumed, sending the dollar lower across the board.

After a brief dip below 1.19 on the release, the EUR/USD pair jumped above 1.1950 toward the end of the trading day. Similar price action was noticed on other dollar pairs, as investors fearing higher inflation fled the dollar.

It is not like the market was taken by surprise. The monetary and fiscal authorities have taken extraordinary measures since the pandemic started. Both monetary and fiscal policies are expansionary still, spurring fear of even higher inflation.

 Even the Fed hinted that inflation would overshoot the target at some point. Last year in August, the Fed changed its price stability mandate from 2% to “averaging 2%”, suggesting to market participants that higher prices will come.

The economic data released recently also pointed to higher prices – hikes are more frequent in retail than wholesale, net share planning to raise price remains elevated at 34%. Hence, the inflation data delivered what feared most –  higher inflation.

Inflation Expected to Peak Around 3.8% in May

With March data, inflation in the United States reached 2.6%, and the gradual rise will likely continue in the months ahead. However, once base effects begin cooling down (e.g., energy prices, supply chain strains), inflation is expected to peak around 3.8% in May.

What does it mean for currency traders? The dollar firmed across the board since the end of the last year, mostly on the back of the EUR/USD correcting from 1.23 to 1.17 two weeks ago. Because the EUR/USD exchange rate weighs the most in the Dollar index, the bounce in the index should not come as a surprise.

However, the EUR/USD found strong support at the 1.17 level as the European Central Bank (ECB) delivered some hawkish statements recently. For example, there is no sign of any significant increase in PEPP purchases – a hawkish development for the euro.

As such, one hawkish development for the euro, coupled with one dovish for the dollar (e.g., higher inflation) contributed to the recent march back to 1.20. That would be key for the EUR/USD in terms of short-term resistance. A break and hold above should trigger more stops.

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