Cooler Inflation Has Taken Some Heat Out From Under The Dollar

Cooler Inflation Has Taken Some Heat Out From Under The Dollar
Stéphane Renevier, CFA

over 1 year ago2 mins

What happened?

Last week wasn’t pretty for the US dollar: the greenback took a serious tumble when the country’s inflation numbers came in cooler than expected.

The US dollar index, or DXY, (blue and white lines) tracks the US dollar’s performance against six other major currencies. It’s trading today at levels not seen since August, almost 7% below its September peak.

What does it mean?

The dollar fell as investors began to believe in the prospects for a “soft landing” economic scenario – i.e. one in which the US Federal Reserve’s (the Fed’s) recent string of interest rate increases would slow economic growth just enough to bring inflation down, but not so much as to push the economy into a recession.

A soft-landing would be great news not just for the US, but also for the global economy, which would benefit from fewer future rate increases and the improving financial conditions that would create. And if the outlook for global growth improves, then investors will gain confidence in assets further afield – sending capital out of the US and potentially into other regions, pushing the dollar lower still. This explains why the dollar fell, and why riskier assets like emerging markets stocks and currencies, as well as commodities rebounded so strongly last week.

Why should you care?

As we explained here and here, a stronger dollar has been one of the biggest headwinds for the global economy and markets this year. If the greenback weakens, even temporarily, it could give the global economy some welcome breathing space, and boost assets that are most sensitive to its strength – like emerging market stocks and gold, for example.

But don’t get too excited: with inflation still running way above target and the economy not likely to have felt the full heat from those rate hikes until the next few months, the soft-landing scenario is by no means a sure thing. So while a correction in the US dollar is quite likely given how far it’s climbed, you might want to think carefully before betting heavily against the greenback. It might take more than a minor cooling in one month of inflation data to move the dollar bulldozer off its course.

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