Exchange rates in an inflationary shock, the dollar rises sharply again (Daily analysis 14.09.2022)

Over the past weeks, Fed members have repeatedly declared the continuation of a firm fight against price pressures. The need to maintain a tight stance in US monetary policy was fully reflected in the inflation readings for August. The result was panic among investors, who instantly lost faith in the recently dominant market trends: a rebound on equity markets and a retreat from the dollar. The EUR/USD has collapsed below parity, and the yen's weakness leaves Bank of Japan interventions hanging in the air.

A month ago, inflation dynamics in the United States slowed down stronger than expected, triggering a temporary euphoria in the financial markets. This time, the reading was above expectations, as has usually been the case this year. The index only fell from 8.5% to 8.3% year-on-year. Not only does the price pressure refuse to let go and is dying down very slowly, but also the nature of the pressure is changing. With a heated labour market, the initial impulse in the form of supply shocks is transforming into demand-driven inflation. Core prices have made their ninth month-on-month jump of half a per cent or more in the last year. As a result, their annual growth rate climbed from 5.9 to 6.3% and is a hair's breadth away from the cyclical record set in March, when the index stood at 6.5% year-on-year.

In such a situation, the Federal Reserve is in no position to let its guard down. With next week's FOMC meeting in mind, a third consecutive rate hike of 75 basis points, lifting the cost of money to a range of 3.00 -3.25% was practically a foregone conclusion even before Tuesday's readings. Investors were quietly hoping that the declared need for further aggressive suppression of price pressures was just a mask and that decelerating inflation in the following months would allow for a gradual moderation and easing of the stance. Meanwhile, following the latest news, some commentators are calling for a move of one percentage point. Such a move is already priced in at almost a third, and respected economist and former US Treasury Secretary Larry Summers has expressed views that such a sharp increase would be a step towards restoring the Fed's credibility. With an outlook for the end of the first quarter of 2023, the valuation of the Fed's rate level is half a percentage point higher than a fortnight ago and implies a ceiling of 4.5%.

An inflationary surprise and a jump in the pricing in future rises are causing panic on the markets. Indexes on Wall Street tumbled by several per cent and erased the large majority of the upward correction of the previous days. The dollar instantly regained its resonance and rose dynamically. The EUR/USD exchange rate, which briefly breached the 1.02 ceiling on Monday, is again below parity. The main currency pair's attempt to break out of the downtrend must be considered unsuccessful. As a result, a further hovering of the EUR/USD around parity appears to be the most likely scenario for the coming days.