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Fundamental Analysis

Currency Futures Slide as Markets Expect Hotter US Inflation

  • The data revealed a decline in US consumer sentiment.
  • US consumers increased their expectations for inflation in the year to come.
  • The Fed’s Lorie Logan said it was unclear whether interest rates were high enough to lower inflation.

Currency futures dropped on Friday as the dollar gained strength on higher US inflation expectations. At the same time, investors absorbed comments from Fed policymakers regarding interest rates. Meanwhile, US consumer sentiment fell.

Data on Friday from the University of Michigan revealed a decline in consumer sentiment. The figures came in at 67.4 in May, well below estimates for 76.0. This is a sign that US consumers are less optimistic about the economy. The report aligned with the recent poor figures from the US on employment and business activity. 

US inflation expectations (Source: University of Michigan)

US inflation expectations (Source: University of Michigan)

However, investors focused on inflation expectations in the report. Notably, consumers increased their expectations for inflation in the year to come from 3.2% to 3.5%. These expectations can drive inflation when businesses start hiking prices in anticipation of higher inflation. Therefore, it can be a big challenge for the Federal Reserve. 

The dollar went up after Fed’s Lorie Logan mentioned that it was not clear if interest rates were high enough to reduce inflation. Investors took this as a hint that rates might need to rise to bring inflation down. Moreover, Lorie cautioned that it was too early to consider interest rate cuts as inflation was still high. 

Consequently, the yen fell against the dollar, raising fears that Japanese authorities would intervene. Japan’s Finance Minister said the government would take necessary action to support its currency.

However, other Fed policymakers were less hawkish. Raphael Bostic said the Federal Reserve will cut rates even though the timing and the size of cuts remain uncertain. Austan Goolsbee also stated that monetary policy was quite restrictive, which could help lower inflation to the central bank’s target.

Meanwhile, the Canadian dollar strengthened slightly on Friday after data revealed a bigger-than-expected jump in employment in Canada. Notably, the economy added 90,400 jobs, beating forecasts and indicating renewed strength in the economy. As a result, investors lowered the likelihood that the Bank of Canada will cut rates in June from 60% to 44%.

Elsewhere, the pound strengthened due to unexpected growth in the UK economy. The GDP data revealed an expansion of 0.6% in Q1, confirming an end to last year’s shallow recession.