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HYCM Market Update: Inflation Takes Centre Stage

Minutes from the Federal Reserve’s November meeting have been front and centre recently. They reveal a Fed ostensibly more concerned with inflation.

Add to this, several policymakers who have said they’d be open to tapering quicker if inflation persists with a view to also hiking interest rates sooner than expected, and you now have a Fed that’s making ever more hawkish gestures. This situation may provide trading opportunities for a variety of instruments in different asset classes, all of which are available to be traded at HYCM.

Lowest US Jobless Claims Since 1969

All this comes off the back of a sub-200,000 US jobless claims print on Wednesday, November 24th, the lowest such print since 1969. However, let’s not forget that the last time this record was broken was with a 207,000 print in July of 2018, with the DXY roughly at where it is today and a US stock market that was heading towards new all-time highs.

At the time, US markets were just several months away from the taper tantrum crash that caused them to lose $2 trillion in October of 2018 alone. It’s interesting to look back and recall that at the time Jerome Powell had been questioning the logic of the accommodative interest rates that had been in place since the 2008 crisis with the Fed funds rate at 1.75% – 2% and a general consensus that he would hike to 3.4% before pausing. This would ultimately fail to come to pass, the last Fed interest rate hike would be the ill-fated December 2018 hike to 2.25% – 2.50%.

Core PCE 2x Fed Target

Of course, much of the recent jawboning from the Federal Reserve is a result of its favourite measure of inflation, core PCE (personal consumption expenditure excluding food and energy), leaping to 4.1%, which is the highest reading since the early 1990s and is also more than twice the Fed’s 2% target. By comparison, back in 2018 core PCE would top out at 2.13% in July.

Gold: Between a Rock and Hard Place

Gold prices were said to be creeping upward due to the inflation print, but in actuality, the yellow metal has hardly budged despite persistent inflation concerns. This is particularly apparent when you zoom out to the longer timeframes (see below). The lack of follow-through is currently being attributed to the aforementioned jawboning from the Federal Reserve. The fear for potential gold buyers is that the Fed is ramping up its taper to be able to raise interest rates sooner in a bid to tame rising prices, and this could hurt gold due to the opportunity cost of holding a non-yielding asset.

The consensus around gold is that it will continue to face significant headwinds, particularly above $1800. In August, it broke bearishly out of a large symmetrical triangle pattern going all the way back to March of 2020. Gold is now treating the upward sloping support line of that triangle as resistance, having been rejected from it in November, when it rallied to $1874. In fact, gold is typically the most-traded metal at HYCM.

Dollar Strength vs Euro Weakness

The Fed’s recent hawkish turn means that the European Central Bank remains the more dovish of the two, which is evident in the euro’s underperformance relative to the dollar, but also in the changing language used by each of the two major central banks. In a statement made to the press following the ECB’s decision to leave rates unchanged in its October meeting, ECB President Christine Lagarde revealed that inflation had been a central topic of concern but that following a great deal of “soul-searching,” central bank officials remained with the view that inflation will prove to be a transitory phenomenon.

The EURUSD chart having recently broken support to trade at levels last seen in the summer of 2020 can be regarded as an ongoing record of this disparity in central bank stances. However, the European Union has a lot more to contend with than just a dovish ECB. Germany’s IFO business climate index recently dropped for the fifth consecutive month, with supply chain bottlenecks, a fourth coronavirus wave, and a new spate of pandemic restrictions all weighing on growth in the region.

With the euro accounting for the largest percentage weighting of the DXY, this dynamic of euro underperformance and dollar outperformance has EURUSD and DXY looking like inverted versions of each other. Perhaps most notably, though, is the fact that this recent surge in the DXY takes its weekly RSI levels to the most overbought they have been since April of 2015.

Watch the BOE

The Bank of England is the central bank to watch now as investors will be keenly scanning BoE member statements leading up to the December 16th meeting. They went into the November meeting having been led by governor Andrew Bailey’s hawkish forward guidance to believe that a rate hike could be in the cards, only to have these expectations dashed by the central bank’s decision to leave them untouched.

This policy head fake had larger-than-expected influences on global sovereign bond markets, and investors will be closely observing whether the Bank of England is to join the hawks in anything more substantial than rhetoric and whether Andrew Bailey will act to stave off inflation following his earlier statements to that effect.

By Giles Coghlan, Chief Currency Analyst, HYCM

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About HYCM

HYCM is the global brand name of Henyep Capital Markets (UK) Limited, HYCM (Europe) Ltd, Henyep Capital Markets (DIFC) Ltd and HYCM Limited, all individual entities under Henyep Capital Markets Group, a global corporation founded in 1977, operating in Asia, Europe, and the Middle East. 

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