Inflation Concerns Drag Equities Lower, USD Rallies

The US dollar rallied, while equities tumbled, with the S&P 500 entering bear market, as market participants became more concerned over high inflation, after Friday’s data revealed an acceleration in the US headline CPI for May. This has also increased speculation that the Fed may need to move faster and more aggressively, with the Fed funds futures now nearly fully pricing in a 75bps hike for tomorrow, instead of a 50bps liftoff anticipated up and until the data were out.

Accelerating US Inflation Sparks Speculation for a Triple Hike by the Fed Tomorrow

The US dollar traded higher against all but one of the other G10 currencies on Monday and during the Asian session Tuesday. It gained the most against NOK, AUD, NZD, and SEK, in that order, while the currency against which it failed to record any gains was JPY. Specifically, USD/JPY was found virtually unchanged this morning.

The strengthening of the US dollar and the Japanese yen, combined with the weakening of the risk-linked Aussie and Kiwi, suggests that the financial community may have continued trading in a risk-off manner yesterday and today in Asia. Indeed, turning our gaze to the equity world, we see that major EU indices traded in the red, with the risk aversion accelerating during the US session and rolling into the Asian trading today. The main losers were Nasdaq, which has already been in a bear market, and the S&P 500, which entered bear market yesterday.

The catalyst behind the steep losses may have been the unexpected acceleration in Friday’s US inflation data. The headline rate rose to +8.6% yoy from +8.3%, at a time when the forecast was for an unchanged number, while the core CPI slowed by less than its own forecast suggested. Expectations were for the core rate to slide to +5.9% yoy from +6.2%, but instead, it slid to +6.0%. In our view, this may have added more credence to the view that the Fed is unlikely to pause its hiking process after summer and may have increased speculation for an even more aggressive path. Indeed, according to the CME FedWatch tool, today, market participants are almost fully pricing in a 75bps rate hike at tomorrow’s gathering, despite several policymakers laying the ground for a 50bps liftoff, and another one of that size in July. It is worth noting that the financial world is assigning a 70% probability for another 75bps increase in July.

In our view, such an aggressive pricing increases the risks for a disappointment. Remember that not long ago, just after the minutes of the prior gathering were out, there was speculation that the Fed may decide to take a break after summer, but this narrative was dismissed by several Fed officials, who they however clearly telegraphed 50bps hikes for the upcoming meetings. So, with the current market pricing, a 50bps hike tomorrow could come as a disappointment and may result in a setback in the US dollar and a rebound in equities.

Nevertheless, even if this is the case and even if the new dot plot falls short of the current market pricing, it may keep the Fed as more aggressive than some other major central banks, like the BoE and the ECB, and thus, we will treat a potential setback as corrective phase. We would expect the dollar to slowly regain that ground.

Now, if indeed officials deliver a triple hike and the dot plot matches market expectations with regards to the future, the dollar is likely to continue climbing higher, despite the latest overstretched reaction against some of its major peers. Just for the record, according to the Fed funds futures, interest rates are now seen peaking at around 4% next summer. Having said all that though, we see the case of officials matching the extremely hawkish market expectations as unlikely. They may prefer to wait for more data to come out before they signal that they will proceed so aggressively.

Nasdaq 100 — Technical Outlook

The Nasdaq 100 cash index fell the most against the other major global equity indices yesterday, breaking below the key support zone of 11505, marked by the low of May 20th, and entering territories last seen in November 2020. Despite rebounding today in Asia, the outlook remains bearish and we would expect another round of selling soon.

A forthcoming wave south could aim for the 10940 territory, marked by the low of October 30th, 2020, the break of which could extend the fall towards the low of September 24th, 2020, at 10665. If that barrier is not able to halt the slide either, then we may experience extensions towards the low of July 24th, at around 10325.

In order to start examining whether investors are willing to keep increasing their exposure to this index, we would like to see a clear break above the key resistance of 12935. This area acted as the upper bound of the sideways range the index traded between May 27th and June 9th, and its break may encourage advances towards the 13545 zone, which provided strong resistance between April 26th and May 4th. Slightly higher lies the 13745 barrier, marked by the inside swing low of April 18th, the break of which could carry extensions towards the 14285 territory, marked by the high of April 21st.

GBP/USD — Technical Outlook

GBP/USD accelerated its downfall yesterday, reaching territories below the key support of 1.2165, which stopped the rate from drifting lower on May 12th and 13th. The rate briefly tested waters last seen in May 2020, but it then rebounded to trade back above the 1.2165 barrier. Having said all that, even if the rebound continues for a while more, Cable remains well below the downside resistance line taken from the high of March 23rd, and thus, we will expect the bears to recharge again at some point soon.

The rebound may continue towards the 1.2325 territory, marked by the inside swing low of May 18th, from where the bears may jump back into the action and push for another test near 1.2165. A break lower could aim for the low of May 18th, 2020, at around 1.2080, the break of which could extend the fall towards the inside swing high of March 25th of that year, at around 1.1980.

On the upside, we would like to see a clear break above 1.2775 before we start examining whether the bulls have stolen all the bears’ swords. The rate will be well above the downside line taken from the high of March 23rd, and we may experience extensions towards the 1.2975 zone, which provided strong support between April 8th and 19th. Another break, above 1.2975, could carry extensions towards the peak of April 14th, at around 1.3150.

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