The US dollar rallied. At the same time, equities tumbled, with the S&P 500 entering a bear market, as market participants became more concerned over high inflation after Friday’s data revealed an acceleration in the US headline CPI for May.
This has also increased speculation that the Fed may need to move faster and more aggressively, with the Fed funds futures now nearly fully pricing in a 75bps hike for tomorrow instead of a 50bps liftoff anticipated up and until the data were out.
Accelerating US Inflation Sparks Speculation for a Triple Hike by the Fed Tomorrow
The US dollar traded higher against all but one of the other G10 currencies on Monday and during the Asian session Tuesday. It gained the most against NOK, AUD, NZD, and NZD, in that order, while the currency against which it failed to record any gains was JPY. Specifically, USD/JPY was found virtually unchanged this morning.
The strengthening of the US dollar and the Japanese yen, combined with the weakening of the risk-linked Aussie and Kiwi, suggests that the financial community may have continued trading in a risk-off manner yesterday and today in Asia.
Indeed, turning our gaze to the equity world, we see that major EU indices traded in the red, with the risk aversion accelerating during the US session and rolling into the Asian trading today. The main losers were NASDAQ, which has already been in a bear market, and the S&P 500, which entered a bear market yesterday.
The catalyst behind the steep losses may have been the unexpected acceleration in Friday’s US inflation data. The headline rate rose to +8.6% YoY from +8.3%, when the forecast was for an unchanged number, while the core CPI slowed by less than its forecast suggested.
Expectations were for the core rate to slide to +5.9% YoY from +6.2%, but instead, it slid to +6.0%. In our view, this may have added credence to the view that the Fed is unlikely to pause its hiking process after summer and may have increased speculation for an even more aggressive path.
Indeed, according to the CME FedWatch tool, today, market participants are almost entirely pricing in a 75bps rate hike at tomorrow’s gathering, despite several policymakers laying the ground for a 50bps liftoff and another one of that size in July. It is worth noting that the financial world is assigning a 70% probability for another 75bps increase in July.
In our view, such aggressive pricing increases the risk of disappointment. Remember that not long ago, just after the minutes of the prior gathering were out, there was speculation that the Fed may decide to take a break after summer.
Still, this narrative was dismissed by several Fed officials, who telegraphed a 50bps hike for the upcoming meetings. So, with the current market pricing, a 50bps hike tomorrow could come as a disappointment and may result in a setback in the US dollar and a rebound in equities.
Nevertheless, even if this is the case and even if the new dot plot falls short of the current market pricing, it may keep the Fed more aggressive than some other major central banks, like the BoE and the ECB, and thus, we will treat a potential setback as a corrective phase. We would expect the dollar to regain that ground slowly.
If officials deliver a triple hike and the dot plot matches market expectations concerning the future, the dollar will continue climbing higher, despite the latest overstretched reaction against some of its major peers.
Just for the record, according to the Fed funds futures, interest rates are now seen peaking at around 4% next summer. Having said all that, though, we see the case of officials matching the extremely hawkish market expectations as unlikely. They may prefer to wait for more data to come out before they signal that they will proceed so aggressively.
NASDAQ 100 – Technical Outlook
The NASDAQ 100 cash index fell the most against the other major global equity indices yesterday, breaking below the critical support zone of 11505, marked by the low of May 20, and entering territories last seen in November 2020. Despite rebounding today in Asia, the outlook remains bearish, and we would expect another round of selling soon.
A forthcoming wave south could aim for the 10940 territory, marked by the low of Oct. 30, 2020, the break of which could extend the fall towards the low of Sept. 24, 2020, at 10665. If that barrier cannot halt the slide either, we may experience extensions towards the low of Jul. 24, at around 10325.
To examine whether investors are willing to keep increasing their exposure to this index, we would like to see a clear break above the key resistance of 12935. This area acted as the upper bound of the sideways range the index traded between May 27 and Jun. 9, and its break may encourage advances towards the 13545 zone, which provided strong resistance between Apr. 26 and May 4.
Slightly higher lies the 13745 barrier, marked by the inside swing low of Apr. 18, the break of which could carry extensions towards the 14285 territory, marked by the high of Apr. 21.
GBP/USD – Technical Outlook
GBP/USD accelerated its downfall yesterday, reaching territories below the key support of 1.2165, which stopped the rate from drifting lower on May 12th and 13th. The rate briefly tested waters last seen in May 2020, but it rebounded to trade back above the 1.2165 barrier. Even if the rebound continues for a while more, Cable remains well below the downside resistance line taken from the high of Mar. 23, and thus, we will expect the bears to recharge again at some point soon.
The rebound may continue towards the 1.2325 territory, marked by the inside swing low of May 18, from where the bears may jump back into the action and push for another test near 1.2165. A lower break could aim for the low of May 18, 2020, at around 1.2080, which could extend the fall towards the inside swing high of Mar. 25 of that year, at around 1.1980.
On the upside, we would like to see a clear break above 1.2775 before we start examining whether the bulls have stolen all the bears’ swords. The rate will be well above the downside line taken from the high of Mar. 23, and we may experience extensions towards the 1.2975 zone, which provided strong support between April 8th and 19th. Another break, above 1.2975, could carry extensions towards the peak of Apr. 14, at around 1.3150.
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