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16.02.2018 02:37 AM
"The devil is in the details": the dollar weakens amid rising inflation

In the foreign exchange market, sometimes there are paradoxical situations that are not invested in the usual framework of understanding. An eloquent example is the recent reaction of traders to the release of inflation data in the US. The consumer price index was better than expected, but after a 20-minute strengthening, the dollar began to actively lose its positions throughout the market. The illogicality of the situation surprised many currency strategists, especially as the yield on 10-year Treasury bonds increased. However, despite all the contradictions, there is certainly a particular logic.

On the eve of the release of data on the growth of American inflation, many feared a repeated collapse of the background market. Let me remind you that for the first time on Wall Street, we experienced a drop in early February due to unexpectedly strong growth in the average wage in the US, as well as the continued strengthening of the labor market.

In response to these figures, the S&P 500 index lost 4.1%, (a record drop for the last 7 years), the Dow Jones indicator fell by 4.6% (the worst performance since 2011), and the Nasdaq declined by 3.8% reaching 6967 points. The stock market collapsed because of the emerging risks of capital flight: according to investors, strong Non Farms data could influence the resolve of the members of the US central bank. Furthermore, if the probability of a four-fold rate hike was not discussed at all earlier on the market, now such a scenario has taken form.

A few days later, the US stock market began to recover, after which analysts began to perceive the current situation as a correction: Non Farms served as just an informational reason for such a move. However, whether this is in fact a correction or the beginning of the long-term downward trend - no one, in fact, does not know. That is why the recent release of the CPI was a kind of marker: either there will be another collapse followed by a decrease, or the stock market will "hold a blow" (in case of inflation, naturally). As you can see, the second option turned out to be correct. But if all of the above is just an effect, then what is the reason?

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In my opinion, the main reason for the weakening of the US currency is the structure of the consumer price index published on Wednesday. Traders analyzed the data and came to the conclusion that all factors, due to which the CPI grew in January, are temporary (seasonal).

For example, in January, due to worsening weather conditions and a snowstorm in the northeastern United States, spot prices for natural gas in the US increased almost 60 (!) times over the average of the previous months. Because of this, the cost of heating has also increased (in the United States, mainly used gas boilers). For the same reason, electricity prices (by almost 130%) jumped to $275 per MW, which is the peak in the last four years. Due to the bad weather, gasoline has also risen in price, and as a result - the cost of transportation services.

Another factor that influenced the growth of the consumer price index is the epidemic of influenza in the United States. The epidemiological threshold has already been surpassed in 48 states (that is, throughout the country, except Hawaii and Oregon), killing more than 60 children. Every tenth visit to doctors across the country is associated with the symptoms of this disease. Hence - the rise in prices for medicines and the stay in hospitals and clinics.

As we can see, all listed circumstances that have affected the dynamics of the CPI are of a temporary nature. In addition, the increase in the index was not a breakthrough, and if we compare the published figures with the dynamics of January from the previous year, then we will see an amazing similarity. On a monthly basis in January 2018, the indicator rose to 0.5% (in January 2017 - to 0.6%), and in annual terms remained at around 2.1% (in 2017 - a jump to 2.5%) . The growth of inflation was also explained by seasonal factors that "operated" until February, after which the CPI began to decline monthly.

It is quite obvious that the Fed carries out a similar analysis of the structure of each key indicator, therefore, it certainly will come to similar conclusions. When the market came to understand that a positive inflationary dynamics does not lead to an "automatic" acceleration of rate hikes, the dollar began to weaken throughout the market. All major indices (S&P 500, Dow Jones, Nasdaq) are in the "green zone", and the so-called "fear index" VIX demonstrates a steady decline.

In other words, the market took a hasty decision about a fourfold hike of the rate this year as a result of the January Non Farm and revised its position after the scrupulous analysis of the CPI for the previous month. Also worth adding is that on Wednesday very weak data on retail sales was released: in monthly terms, the indicator was at the lowest level for the whole of last year. The combination of these circumstances led to a decline in the dollar and, accordingly, the growth of the euro/dollar pair.

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At the moment, the eurusd pair are actively trying to enter the 25th figure, repeatedly testing the local high. From a technical point of view, there is a high chance of a retest of 1.2538 (the three-year peak reached in January of this year). But in this case, you need to be careful: traders need at least gain a foothold in the 25th figure in order to test the price level mentioned. If the price remains at current levels on on Thursday or Friday, next week we will see another downward pullback of the price.
Irina Manzenko,
Analytical expert of InstaForex
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