Expectations from investors concerning inflation data and tapering of stimulus by the Fed seem to have a positive impact on the US dollar. It trades close to its 4-month high. As of this writing, the US dollar index (DXY) trades at about 93.15.
The US dollar has been bullish since late last week following the last CPI data and the increasing possibility that the Fed might start tapering stimulus earlier than scheduled. The US dollar’s major competitors aren’t performing as expected thus far. The Yen continues to trade around a multi-week low while the Euro keeps declining to lower levels more than as seen this year.
A positive CPI report will increase the possibility that the US central bank may reverse its dovish stance quicker. A Reuters survey reveals that economists are expecting a 0.6% rise in the month-on-month (MoM) CPI data for July and a 5.4% increase in its year-on-year. If the actual CPI is close to any of these predictions, the US dollar will be further strengthened.
Other Factors That Could Affect The US Dollar’s Strength
Apart from the inflation data, the speech by Esther George, Kansas Fed president, will also be of interest to investors. George is expected to provide insights on when the central bank might start withdrawing its monetary policy and reverse its dovish stance on the stimulus package.
Another critical factor that can affect the Fed’s decision is the spread in COVID-19 cases. Hence, investors will also be monitoring data about the infections from time to time. With the labor market healing fast and consumption rates rising geometrically, the Fed can afford to tighten its monetary policy since the US economy is close to returning to normal levels.
While about 5.8 million jobs need to be filled before the labor market can return to its pre-pandemic position, almost three million employees retired early during the heat of the pandemic. Hence, if the subsequent three CPI data are similar to the last one, then the US economy is about to negotiate a complete recovery.
This is a possibility because the Fed is stopping its generous unemployment benefits, and there are lots of open job opportunities that the returning workforce is about to fill up. More importantly, Congress is set to release trillions in the new spending plan to hasten recovery.
The Next Inflation Report Will Be Key
The Fed won’t want to keep buying over $125 billion worth of bonds and mortgage-backed securities for too long. That could result in a financial market bubble and overload the economy. Hence, it would want to start tapering the stimulus gradually to avoid removing it suddenly and shocking the system.
The next inflation data will determine how quickly the Fed will announce the tapering process and when it will start. If the unemployment data for august is superb, tapering might start by December with the announcement made next month. However, if the data isn’t as expected, the Fed might wait one more month before making the inevitable announcement.