After an unparalleled period of US dollar strength and risk-off moods, markets seem to have taken a breather this week.
Since the end of the second quarter, the US Dollar Index has surged nearly 3 per cent and is currently consolidating above 107 levels.
The underlying issues fuelling the recent dollar rally have remained unchanged and this week’s moves can be seen as a short-term relief rally.
The theme of hotter-than-expected inflation continues after last week’s US consumer price index — the critical measure of US inflationary conditions — came in higher than expected at a 40-year high of 9.1 per cent versus a previous reading of 8.6 per cent.
US inflation hits 40-year high of 9.1%
This sparked fresh dollar buying in anticipation of a more hawkish US Federal Reserve, which will reconvene on July 27 (10pm UAE time) to decide its next interest rate rise in an effort to rein in rising inflation.
Markets were anticipating a 1 per cent increase at the Fed meeting.
But, after comments by Atlanta Fed president Raphael Bostic and St. Louis president James Bullard that interest rates moving “too dramatically could undermine the positive trends still seen in the economy and add to the already large amounts of uncertainty”, markets are now factoring in a 75 basis point increase.
This move would follow the Fed's increase of 75 basis points last month.
Economic data in the US is showing some signs of improving — despite inflation that is near to peaking.
US retail sales released last Friday showed an increase of 1 per cent month on month during June, which further pointed to signs that the current rate rise squeeze and increasing consumer prices are not as damaging to retail spending as initially thought.
This led to major US bourses clawing back some of the earlier weeks’ losses to close Friday on a positive note.
Meanwhile, earnings season is expected to continue this week.
After a mixed run from banking heavyweights, Tesla, Johnson & Johnson, ASML and Netflix are all set to announce earnings this week.
Keep an eye on the earnings per share announcements and how the revenue of these mega-cap companies fared during the second quarter.
Any missed expectations on the downside regarding revenue could further rile investor confidence in the short term.
Demonstration in Brussels against cost of living - in pictures
Also due this Thursday (4pm UAE time) is the European Central Bank's policy announcement on interest rates.
Markets are heavily pricing in a 25 basis point increase, which would be the ECB's first interest rate rise since 2011.
The eurozone is battling higher-than-expected inflation, but is in stark contrast to its counterparts in the US and UK, where the rate-rise cycle has already kicked in.
The interest rate differential has, as a result, piled the pressure on the euro.
This month, EUR/USD is down more than 3 per cent at the time of writing and — for the first time in 20 years — the currency pair traded at parity.
The reversal from parity was quick and sharp and while EUR/USD now finds consolidation above 1.01 levels, that parity level continues to remain a vital psychological support level.
If we see a dovish ECB over the coming months, the parity level could be tested much more strongly before the end of summer.
Meanwhile, gold — normally a safe-haven hedge against rising inflation — had sunk to $1,716 levels at the time of writing.
The recent dollar strength has kept gold bulls in check and I expect the precious metal to continue to trade range bound with a slight bearish bias.
The channel between $1,665 and $1,680 remains a vital support level in the short term and initiating longs here could prove to be the most productive strategy. However, upsides will be capped at $1,745 levels throughout July.
Other crucial data points to look out for on the economic calendar this month include US home sales, which is due out on July 26, and the US gross domestic print on July 28. GDP is expected to come in at 1 per cent quarter on quarter, compared with a previous reading of negative 1.6 per cent.
Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers
