Inflationary shock boosts the dollar (Daily analysis 14.07.2021)

A powerful jump in US inflation is lifting the dollar and expectations that the Fed will accelerate its policy normalization.

The result is another decline of the EUR/USD pair to the key barrier near 1.18. Crossing this level, if possible, will open the way for further strengthening of the dollar.

Record inflation supports the dollar

In June, consumer prices in the USA were 5.4% higher than a year earlier, while the forecast was for the rate to fall below 5%. The data came well above expectations for the fourth consecutive month, and the inflationary shock was amplified by the year-on-year jump in the core rate to 4.5%. Such high values were last recorded in the early 1990s. No wonder, then, that the readings became fuel for the narrative that the Fed was wrong in asserting that the price increases were temporary. As a result, interest rate increases before the end of 2022 were more boldly priced in. This supported the dollar and put emerging market currencies under pressure.

Relief may come from Jerome Powell's speech to Congress today and tomorrow. The Chair of the Federal Reserve is not one of the policymakers who have been expressing concern about the growing inflation and calling for quick normalization of the policy. What is more, inflation readings alone are not enough to determine which stance will prevail in the coming weeks. If economic data on growth, e.g. Friday's retail sales, disappoint, the stagflationary view that the economy is slowing down and inflation is on the way up may prevail. If a few weaker readings do not turn into a longer series, the "reflationary" rhetoric, in which robust demand intensifies price pressures, may return. Right now, the market is still at a crossroads.