The foreign exchange market is on edge ahead of the US May inflation numbers. These foreign direct attractions will have major impacts on currency trends. Traders and economists are itching to get their hands on this extremely important data. They should be concerned about concrete effects on the internal value of USD, as inflation risk continues to trend upwards. The big data ahead will be a key test for the USD. Experts cautioned that just because inflation is going up, doesn’t mean that will result in a greater value for the currency.
For all the talk of market resilience in recent weeks, sentiment really did do a 180 on this realization. Economists across the spectrum are becoming alarmed by the stabilizing impacts of inflation. Their fears only escalated after the release of surprise tariffs well above expectations after ‘Liberation Day.’ This has raised new questions about how these types of policies will affect pricing and consumer choice.
Lessons learned from the difficulties central banks encountered with persistent low (sub-target) inflation, most notably during the entire decade of the 2010s. In sharp contrast with today’s dynamics, low inflation during the 1970s played a much lesser role in undermining the price of the USD. As the Federal Reserve (Fed) has recently indicated, the risks to its dual mandates of stable prices and maximum employment are now more balanced, highlighting a potential shift in policy approach.
Regardless of these alerts, a number of analysts claim that increasing inflation would not necessarily mean a stronger USD. Their takeaway is that the USD can no longer count on rising inflation expectations to help it. A new permanent inflation shock would reduce the currency’s purchasing power. Without a forceful response from the Fed, that could go unchallenged.
“There is no guarantee that rising inflation risks will lead to a stronger USD.” – FXStreet and the author
The relationship between inflation and the USD has flipped over time. In fact, an analysis of data from 2002 up until today shows an almost nonexistent relationship between inflation rates and currency value. This observation raises the interesting possibility that classical economic theories that characterize inflation’s impact on currency should be reexamined.
Just as traders await May’s inflation figures, all eyes are suddenly focused on smog-proofing their own market confidence against whatever bubble-popping news the numbers might bring. Adding to the difficulty of predicting currency movement, recent statements from the Fed point to a more dovish outlook.
Most economists think that the tariffs enacted during this window indeed had an impact on prices observed in May. Yet they claim these changes occurred without consumers noticing. This perception can lead to a feeling of angst around the pending data drop. These are significant developments with potential sweeping ramifications for domestic and global markets, and analysts remain focused on their possible impact.
“Admittedly, these are medium-term arguments.” – FXStreet and the author
Second, the economic environment is changing fast. As USD direction is concerned, inflation dynamics just don’t seem to carry the weight they used to. In reality, inflation was a distant second on the priority list for most decisionmakers going into the pandemic. This important historical context highlights how difficult it is to interpret current data and future projections.