How US Inflation Data Could Affect the Forex and Bond Markets
US inflation data to be in focus this week
Inflation data for the US economy is scheduled to be reported on August 11. It is the only major economic data to be reported from the US economy this week and could help determine the next steps of the Federal Reserve.
The Fed has been concerned about the slowing growth of inflation (TIP) in recent months and has termed the slowdown as transitory until the recent FOMC meeting. In the last FOMC meeting in July, the FOMC statement said that it would take much longer than expected to reach the 2% inflation target that the Fed has set for itself.
This was a dovish change of tone from the Fed after months of hawkishness and has led markets (BND) to believe that the next rate hike would occur after 2017.
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Fed’s inflation worries
In their recent speeches, most of the FOMC members have cited slowing inflation as the primary reason to limit the pace of rate hikes. The recovery in the US economy has been impressive so far, with business expectations booming and unemployment levels falling to record lows.
A lower level of unemployment is usually followed by rising demand and inflation (VTIP), but that has not been the case in this recovery. Many industry observers believe the reason for this imbalance is the extraordinary monetary policy, which saw the Fed stimulate the economy through its quantitative easing programs. Lower inflation levels are likely to limit the Fed’s plans to normalize the US economy.
Inflation and the markets
The segment that is most impacted by inflation is the bond market. Lower levels of inflation impact long-term interest rate expectations. This has been evident in recent weeks with the yield curve flattening, where short-term rates (SHY) were rising faster than the long-term (TLT) rates.
If Friday’s inflation numbers are below expectations, we can expect a further drop in bond yields and the US dollar (UUP). The US dollar could depreciate if the Fed could be expected to hold off further rate hikes, while other economies would continue with their tightening plans.