US Dollar May Shrug Off Soft Inflation As Yellen Remains Hawkish

Fundamental Forecast for the US Dollar: Neutral

The US Dollar managed to find support after sliding to a 10-month low last week. A relatively steady stream of upbeat economic data surprises brought upbeat ISM manufacturing- and service-sector readings as well as rosy payrolls numbers. Minutes from June’s FOMC meeting were also cautiously upbeat. A clear-cut balance sheet reduction plan is yet to emerge but officials’ appetite for rate hikes seems undiminished.

Indeed, it seems somewhat odd that the greenback’s gains were not more pronounced. The tightening path implied in Fed Funds futures still see a better-than-even chance of another 25bps increase before year-end, but the probability margin is razor-thin at 52 percent and virtually unchanged from a week ago. Put plainly, it seems investors are still skeptical.

Sluggish inflation may explain the markets’ relatively dovish disposition. Disappointing wage growth data was an obvious blemish on June’s otherwise impressive employment statistics. The aforementioned ISM surveys also pointed to a slowdown in price pressure. That bodes ill for what may cross the wires when PPI and CPI numbers are published next week.

Were that all that is on offer, the greenback might seem clearly vulnerable. As it happens, it is not. Congressional testimony from Fed Chair Janet Yellen may yet tip the scales in the US currency’s favor. The latest PMI surveys offer a glimpse of what she may argue. They show factory-sector input price growth plunging while the services side still looks robust, presumably echoing cheaper raw materials.

This seems to support the Fed’s argument that recent disinflation owes to temporary forces while the underlying price growth trend remains on-track. When those transitory influences are rebased out over time, the case for gradual tightening will appear clear enough. If Yellen is able to articulate this stance clearly and convincingly, traders may finally buy in and push the US Dollar up in earnest.