On Wednesday, the U.S. reported worse-than-expected inflation data…and the markets rallied. The U.S. dollar, on the other hand, dropped.
On Tuesday, the dollar was headed for the highest exchange rate against the Euro this year. Yet within 24 hours, the rally was cut short by Wednesday’s release of U.S. inflation data.
The July U.S. Consumer Price Index was at 5.4% year-over-year. That’s worse than the expert consensus estimate of 5.3%. For reference, the Federal Reserve’s “target inflation rate” is 2%.
High inflation is typically a warning sign for central banks. If it stays too high above the “target rate,” central banks reign it in with reduced asset purchases and higher interest rates.
Higher rates are bad news for the markets, as they typically cause stock valuations to go down. That’s why the markets drop at any sign of the Fed tapering. At the same time, the dollar strengthens against other currencies.
With inflation outperforming expectations, and well above the 2% target, the Fed should taper, right? That should then cause the dollar to strengthen and the stocks to drop. Well, the markets disagreed.
What happened was exactly the opposite.
Markets were mixed the CPI release and shot up higher later. The dollar index was up before the release, and down later.
How can this be? It looks like investors were expecting inflation to go up, even as “expert consensus” was predicted a slight drop in the inflation rate.
In fact, the markets reacted as if 5.4% inflation was good news! Their worse fears did not materialize.
It looks like investors are much more concerned about inflation than experts and the Fed are. Maybe this should be a wake-up call for both.