Why market volatility will persist until US inflation and labour market pressures ease

Weaker-than-expected US data readings will spark dollar rallies and affect stocks

Traders at the New York Stock Exchange in Manhattan. US equity markets rallied on the back of a softer US consumer price index report last week. Reuters

Markets remain mixed after a weaker-than-expected US inflation report.

Last week, US equity markets rallied on the back of a softer US consumer price index (CPI) print, which is a key measure of inflation.

US consumer prices came in slower than expected and judging by the immediate pricing action, it calmed the overall inflation threat rhetoric.

The headline month-on-month CPI print came in at 0.0 per cent, versus a previous reading of 1.3 per cent. Longer-term CPI came in at 8.5 per cent year on year, versus a previous reading of 9.1 per cent.

While the headline number dropped due to falling energy prices, the core CPI print (less food and energy) also showed signs of improvement.

The month-on-month core print came in at 0.3 per cent in July, down from a June reading of 0.7 per cent, while the year-on-year print came in at 5.9 per cent, unchanged from June.

The release immediately led to dollar weakness across the board. Major counterparts in the FX segment rallied against the greenback, while US equity bourses also cheered the news.

The optimism has been short lived, with markets rallying in favour of the US dollar this week and overall still remain mixed.

The yield curve on US Treasuries remains inverted (yields on shorter-term US bonds higher than longer-term yields).

This suggests the bond markets’ outlook is that the current rate hike cycle may have reached its peak. But gauging the move on the dollar index, the markets seemed to be receiving mixed signals.

The Fed will continue to remain data dependent and adopt a wait-and-watch approach.

We have one more inflation reading and another jobs report — and unless we see more gains in both prints, we expect the uncertainty to continue.

This week’s Federal Open Market Committee meeting minutes, due at 10pm UAE time today, will offer more insights into how the committee is currently balanced.

Recall the Fed’s mandate — they seem set to continue tightening monetary policy until the US data docket is convincing enough to support the challenge that inflation has peaked (and is falling) and the labour market continues to show positive signs of employment.

Again, with the data we have on hand, we need to see more to challenge the aforementioned Fed’s policy mandate.

In the interim, markets will shift between a 50 basis-point hike and a 75 basis-point hike.

If we see stronger-than-expected US numbers, expect strength in the US dollar and vice versa. This theme of good news is bad news for markets (and vice versa) is set to continue.

Also, coming up on the calendar is July retail sales data for the US, which should help build a picture on the developing inflation theme.

US core retail sales are expected to have shrunk by 0.1 per cent in July, with overall retail sales (excluding automobiles) expected to have increased by 0.1 per cent in the same period.

The US gross domestic product print, due on August 25, will be a key component in market volatility through the end of the month. After consecutive weaker readings, growth in the second quarter is expected to keep shrinking by 0.9 per cent.

Personal spending data and Michigan consumer sentiment due on August 26 will wind up the important data prints for August.

Weaker-than-expected readings will spark dollar rallies in the interim and vice versa.

Considering these factors, I expect buying support to come into the dollar index at $104.70, with upsides capped at $107 through the end of August.

Gold longs look appropriate at $1,680 levels, with upsides capped at $1,920 levels.

After a strong last week, the EUR-USD pair seems to have run out of steam in the run-up to 1.04 levels, which will remain the near-term resistance in the cross.

Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers