USD Climbs to 16-Month High as Inflation Index Sees Biggest Surge in 31 Years

The US dollar has surged on Wednesday following the inflation data released by the Labor Department. The USD index, which tracks the greenback against six other currencies, has increased by 0.90% to fluctuate at 94.793, hitting the highest since July 2020.

Thus, the USD index maintains inside a bullish channel that started in June.

The weekly chart shows that the price has just managed to break above key resistance at 94.730, a level not seen since October 2020.

Meanwhile, EUR/USD has tumbled to the lowest since July 2020 as well, losing 0.86% so far on Wednesday. The pair is trading at 1.1412.

This is the US dollar’s largest daily gain since the beginning of the year, and momentum is still there.

The greenback has surged as the higher-than-expected inflation is adding to expectations that the Fed might start raising the interest rate sooner than initially planned. The central bank announced last week that it would start reversing the accommodative monetary policy by reducing its bond purchasing by $15 billion per month.

US CPI Saw Largest Annual Gain Since 1990

The Labor Department said on Wednesday that the consumer prices index (CPI) surged last month by 0.9% after adding 0.4% in September. The largest increase in four months led to annual growth in the index to 6.2%, which is the highest annual gain since November 1990. In September, the year-on-year gain was 5.4%. Analysts expected the CPI to increase by 0.6% last month. 

The surge in inflation was driven by gasoline prices, which jumped 6.1% in October after rising 1.2% in the previous month.

Meanwhile, food prices rose almost 1%, driven by meat, fish, eggs, vegetables, cereals, and bakery products.

The Fed had repeatedly said that high inflation is transitory, but investors are increasingly worried that the inflationary pressure will maintain next year as well, especially given the global supply chain issues. The labor market is also struggling, as the shortage of workers leads to higher wages.

Separate data from the Labor Department showed that the number of US citizens applying for unemployment benefits dropped to a 20-month last week, although economists expected an even larger decline. Initial jobless claims fell to 267,000, a fresh post-pandemic low. Analysts surveyed by the Dow Jones expected the indicator to come in at 269,000.

Speaking about salaries, high inflation is offsetting the increase in wages, prompting investors and consumers to question the Fed’s ultra easy monetary policy. The concerns are also adding to the political risk for US President Joe Biden.

Ryan Sweet, a senior economist at Moody’s Analytics, told Reuters:

Risks are clearly shifting toward US inflation remaining elevated longer than previously thought, but that doesn’t mean that it’s permanent. The Fed could face a situation where higher consumer prices begin to weigh on consumer spending, reducing GDP growth.”

The Core CPI, which excludes the volatile prices of food and energy goods, increased by 0.6% in October after adding 0.2% in the previous month, while economists predicted growth of 0.4%. The indicator was boosted mainly by rents. Meanwhile, prices for hotel and motel accommodation surged 1.5%. The cost for used cars and trucks bounced back by adding 2.5% after dropping for two consecutive months. Prices for new cars increased 1.4%. The global semiconductor shortage has caused vehicle prices to accelerate for the seventh straight month. Healthcare costs rose 0.5%, the largest increase in about one and a half years.

In annual terms, the core CPI accelerated to 4.6%, the largest increase since August 1991, after staying at 4.0% for two consecutive months.

Given the high-than-expected inflation and ongoing concerns that it may not be temporary at all, economists and investors anticipate the Fed to increase the interest rates from their record low starting with the end of 2022, although this may happen sooner.

Alexander Lin, an economist at Bank of America Securities, was cited by Reuters as saying:

“The heat seen in rents and across services could make the Fed begin to sweat as they wait out the return in the labor supply and easing of supply constraints over the coming months. Clearly the risks are for the timing of rate hikes to be pulled forward.”

If high inflation continues to put pressure next year, the Fed might be in trouble because even its rate hikes might not be enough to address inflation, as the problem lies in the supply chain bottlenecks and fiscal spending, which the central bank doesn’t directly control. The Fed might be forced to intensify tapering and increase the interest rates at a higher pace, which would hit stocks and bonds.

Fed officials, including chair Jerome Powell and vice-chair Richard Clarida, recently reiterated that current high inflation would eventually go back to normal as supply chains and job markets adjust. However, the latest CPI data is a big headache for the Fed, and economists are questioning the Fed’s “transitory” rhetoric. Eric Winograd, a senior economist for fixed income at AllianceBernstein, told the Financial Times:

Transitory is dead and buried. There is a good chance we will see core CPI close to 6 per cent over the next few months.”

As a rule, whenever the central bank of a country adopts hawkish rhetoric and starts increasing the interest rates, its national currency strengthens versus counterparts as it becomes more attractive to deposit. Otherwise, low interest rates are making the national currency less attractive to hold, prompting investors to get exposure to stocks and consumers to spend their money. The Fed has cut the interest rate to record lows again following the pandemic in an attempt to support the economy by encouraging consumption and investments. However, the massive amounts of free cash can also hurt the economy when inflation is out of control.

US Producer Prices Surge 0.6% in October

The confirmation of high inflation came on Tuesday when the US Labor Department said that prices paid to producers accelerated by 0.6% in October compared to the previous month, in line with analysts’ expectations. The increase was driven by higher prices of goods. The producer prices index (PPI) jumped 8.6% year-on-year, although economists were anticipating the reading at 8.7%.

The core PPI, which excludes the food and energy costs, rose 0.4% from September and 6.8% year-on-year.

The report highlighted how supply chain bottlenecks, materials shortages, and an uptick in labor costs caused an increase in prices across the economy.

Over 60% of the index increase was caused by rising costs of goods, which jumped 1.2%.

Companies are forced to pass the costs onto consumers, maintaining the inflationary pressure. Eventually, that was reflected on Wednesday by the surge in the CPI.

What’s Next for the USD?

The US dollar may continue to increase and try to recover the post-pandemic losses at least partially. In 2019, the USD index used to fluctuate above 99.00, but the start of the pandemic caused it to tumble below 90.00 amid the Fed’s ultra easy monetary policy.

Today, as the central bank is forced to reverse its accommodative stance, the dollar is gaining traction and may continue to fluctuate inside the bullish channel and break above the psychological level of 95.00 sooner than later.



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