Last Thursday’s Consumer Price Index showed that US prices grew 7.7 per cent year on year in October and core inflation (excluding food and energy) grew 6.3 per cent annually.
While the readings are still uncomfortably higher than the US Federal Reserve’s 2 per cent target, they were lower than what markets were expecting and sparked a wild buying rally in stocks.
The benchmark Dow Jones index rallied more than 3.8 per cent following the announcement on Thursday, while the S&P rose more than 5.7 per cent.
Watch: US Federal Reserve chief warns of 'pain' in reducing inflation
But perhaps the biggest gainer was the tech-heavy Nasdaq, which had one of its best days in recent memory after gaining more than 7.5 per cent.
Following the aftermath of the surprise CPI news, the biggest loser has undoubtedly been the dollar.
The US Dollar Index, a measure of the greenback against a weighted basket of major currencies, sunk 2.2 per cent on the day and fell another 1.4 per cent during Friday’s trading session, in one of the most aggressive two-day drops since 2008.
The long dollar trade has been very much in fashion amid the Fed's current rate hike cycle — the index peaked at 114.50 at the end of September — and up until a week ago, it seemed there were even more legs in the greenback's rally.
However, the inflation report will serve to boost market expectations that pricing pressure has peaked in the US.
Data showed that futures prices for the Fed funds rate fell below 5 per cent and expectations rose to 71.5 per cent that the December Fed meeting could yield a hike of only 50 basis points rather than 75 bps.
October’s inflation report shows encouraging signs — a deep dive into the report showed that most categories within the CPI reading were cooling off, with medical care and used cars recording the biggest drops, while the cost of shelter continues to rise.
While markets remain optimistic about the CPI report, it is important to note that inflation remains almost four times that of the Fed’s target — and the central bank will continue its rate hike cycle, albeit at a slower pace than previously forecast.
Over a longer-term time horizon, the Fed still has a lot of work to do, as noted by Dallas Federal Reserve president Lorie K Logan last week.
However, the recent stock rally could turn out to be more of a relief rally, depending on the outcome of November’s inflation report, which is due out on December 13.
We would need to see another run of cooler numbers in that report to entertain the notion that inflation has well and truly peaked.
The next US payrolls report, due out on December 2, will also be a key metric in market volatility. Another stronger-than-expected jobs report will keep the dollar weaker.
In the short term, the sentiment doesn’t bode well for dollar long positions. However, in the medium term, I expect markets to return to Earth following the hype around the recent inflation report.
As mentioned earlier, the Fed still has a long way to go to bring inflation down to its 2 per cent target and struggling with downbeat growth is still a very really issue for the US.
It is alarming that the two-year US Treasury yield has dropped below the 10-year yield to its lowest level since the mid-1980s, hinting that the current rally in US asset classes is unsustainable.
On Wednesday, we have the release of October's US retail sales, which will be another key indicator of how US prices are faring — and will either fuel or impede the current rally in markets.
Data is expected to show that month-on-month core retail sales grew 0.4 per cent, up from 0.1 per cent in the previous month.
Better-than-expected retail sales will force the Fed to remain hawkish, as a stronger print would suggest added price pressures and vice versa.
In what has already been a turbulent 2022 for financial markets, last Thursday will remain a monumental day.
However, I don’t think we are out of the woods yet — and would need to see the US data points expected over the next few weeks before building longer-term positional trades.
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