Why US inflation data could test the current bull market run

Slowing price rises fuel speculation that the Fed will taper the pace of rate increases and cause the dollar to weaken

Traders at the New York Stock Exchange. Weakening US wage growth in December spurred a rally in equities. Reuters

Financial markets have opened 2023 on a positive note, with stocks, currencies and commodities moving higher against the US dollar.

The US Dollar Index, a measure of the value of the greenback against a weighted basket of major currencies, fell below 104 this week and was testing a key support level at 103.4, the lowest since June, at the time of writing.

The move was exacerbated by China reopening its borders at the weekend, fuelling optimism that it would boost the country's economic activity and resulting in higher markets in Asia and Europe.

Looking ahead, markets will continue to focus on the US inflationary situation, with Consumer Price Index data — a key measure of US inflation — due on January 12.

Markets are poised for another slowing inflation print, with the annual CPI expected to fall to 6.5 per cent in December, from 7.1 per cent in November.

Core CPI prices (excluding food and energy) are expected to slow annually to 5.7 per cent, from 6 per cent in November.

This would be the sixth consecutive lower CPI print, following inflation peaking at 9.1 per cent in June last year.

Slowing inflation will stoke further speculation that the US Federal Reserve will slow its pace of interest rate increases, which will ultimately lead to a weaker dollar and more appreciation of asset classes against the greenback.

We saw this during last Friday’s US non-farm payrolls report, which was mixed at best.

While new jobs increased more than expected — 223,000 versus 200,000 — it was negative compared with November’s figure of 256,000.

But markets rallied on the news that average hourly earnings slowed to 0.3 per cent month on month and 4.6 per cent year on year (versus forecasts of 0.4 per cent and 5 per cent, respectively).

The weakening wage growth drove up equities, with the US dollar continuing to sink on Friday, which started the short-term bull rally we find ourselves in.

This could quickly change with Thursday’s inflation report.

It is also the start of fourth-quarter earnings season in the US, with banking heavyweights Wells Fargo, Bank of America and JP Morgan Chase leading the way with their announcements this week.

Despite higher-than-expected inflation, a cooling in earnings reports could irk markets with fears of a potential recession.

Overall, the theme of good news being bad for markets and bad news being good for markets (equities and asset classes against the US dollar) is set to continue.

In addition to the above fundamentals, the US Dollar Index also looks susceptible.

Watch: US Federal Reserve chief warns of 'pain' in reducing inflation

After breaking through the 50-week moving average in December, the index has found resistance in moving back above 104.4 levels, with 103.4 a more likely level to be tested.

Across the pond, we have a relatively light economic calendar for the euro area.

The EUR/USD currency pair has benefitted from the recent downwards dollar move and the common currency looks to test a key resistance level between 1.0740 and 1.0770, which has not been seen since May.

Overall, I would continue to exercise caution amid the current market turbulence.

Waiting for the inflation report on Thursday may prove prudent before building any medium-term trading strategies.

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