The US dollar saw a boost as the market eagerly awaited a crucial US inflation report. The dollar's performance was influenced by safe-haven buying and surge energy prices. Amid this backdrop, scenario analysis explored the potential outcomes. A key focus this week in foreign exchange markets has been the strengthening US dollar, with the US dollar index (DXY) marking a 0.5% increase for the week. It was set for a fourth consecutive weekly gain in anticipation of the upcoming inflation data.
Despite the usual expectation that positive US inflation data might lead to a weaker dollar, the greenback found support from safe-haven buying. This was fueled by concerns arising from weak Chinese data and the downgrade of several US banks by Moody's. In the ever- shifting landscape, as one concern recedes, another takes its place. While bond markets have started to accommodate rising supply, the soaring energy prices are emerging as a new focal point. This introduces the potential to disrupt the narrative of deflation or a soft landing.
Overnight, European gas prices surged by 30%, and crude oil prices continued their upward climb, pushing WTI crude to close at a nine-month high above $84.00 a barrel. Given this recent spike in energy costs, higher-than-expected inflation data from the upcoming report could amplify concerns. In such a scenario, markets might downplay the weaker inflation data seen previously. Last month, the headline US consumer price index (CPI) dropped to 3% from May's 4.0%, marking a two-year low . Similarly, the core consumer price index (CPI), excluding volatile items, eased back to 4.8%, the lowest since October 2021 and down from May's 5.3%.
Anticipated inflation figures suggest a 0.2% month-on-month rise for both overall CPI and core CPI this month. These forecasts could lead to a moderate increase in headline interest rates to 3.3% year-on-year, while core inflation is expected to hold steady at 4.8%. The projected range for headline inflation spans from 3.5% to 3.1% year-on-year. If headline inflation surprises 3.5% year-on-year, US yields and the dollar could surge as bond market vigilantes come into play. The S&P 500 might also need to grapple with the 4400 level.
Potential Scenarios and Impact on Markets
In the event that headline inflation falls between 3.2% and 3.4%, the Federal Reserve might hold steady in September, allowing other factors to influence bond and stock markets. The dollar could maintain its outperformance, bolstered by rising energy prices. On the other hands , if headline inflation stands at 3.1% or lower, US Treasury yields could retreat from last week's highs. This might lead to a rise in US stocks, potentially pushing the S&P 500 to revisit the 4,550 mark in upcoming sessions. Consequence ently, the dollar might experience weakening, especially against currencies like the Australian dollar.
In the first half of 2023, the US dollar index encountered and held the support level of 101.00/80 on three occasions before experiencing a further decline following weaker-than-expected inflation data last month.
