Weak U.S. Economy, Low Inflation May Keep Fed on Sidelines
The U.S. dollar’s six-year rally may be coming to an end as the economy fails to show the kind of momentum needed to take this surge to the next stage.
According to analysis by The Wall Street Journal, the currency’s 36% surge since 2011 is entering its last stages, following weaker economic recovery in the United States that was hurt by muted inflation and consumer confidence.
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A sluggish economic growth and inflation reading below the U.S. Federal Reserve’s danger zone are the two main reasons why the central bank won’t accelerate the pace of interest rate increases as expected by dollar bulls.
The U.S. dollar gained about 2.5% in October, which is on track for its second-largest monthly appreciation of the year.
“After such a big move, you eventually need to wonder when the correction is going to come,” said Thomas Flury, head of currency strategy at UBS Wealth Management, which oversees some $2.0 trillion worldwide. “This rally seems to be coming to an end.” (Source: “Climbing Dollar Expected to Hit Ceiling,” The Wall Street Journal, October 26, 2016.)
The U.S. Fed, in its last interaction with the markets, has signaled that a December rate hike is a possibility, given the strong job gains and some signs of wage inflation.
But last month’s increase in inflation was in line with economists’ expectations, while the underlying inflation moderated amid a slowdown in increases in healthcare costs after recent robust gains.
The core consumer price index (CPI), which strips out food and energy costs, rose 0.1% in September after climbing 0.3% in August. That slowed the year-on-year increase in the core CPI to 2.2% following a 2.3% rise in August.
But, despite this slowing inflation, bets still remain strong that the Fed will raise interest rates this year, at a time when other major central banks maintain monetary easing.
Traders are pricing in a 71% possibility of a U.S. rate hike by December, bolstered by Chicago Fed President Charles Evans’ comments saying that it may be appropriate for policymakers to raise rates three times by the end of 2017.
So far, it seems that the dollar bulls are winning the battle if you look at the U.S. dollar’s recent momentum.
