Not just risk off
As the rally in the US Dollar continues to gain traction this week, it is increasingly hard to write it down to risk alone. As we highlighted yesterday, strong demand for safe-haven assets has largely been attributed by financial media to rising tensions in the Middle East. Looking at the spectrum of US fixed income, that seems hard to believe. Throughout this universe you will find a concerning feature: rising marginal inflation rate expectations.
The reasons for rising inflation expectations are widespread. One increasingly concerning contributing factor is the dockworker’s strike in the US which if unresolved will inhibit the capacity and supply. Add to that evidence of a strong private US labour market (as evidenced this week by the ADP and JOLTS reports) and it is easy to see why the tide may be turning on US inflation expectations once again. When we reconsider the US Dollar’s 2 cent rally this week within major crosses as a consequence of shifting inflation rate expectations, it suddenly becomes far more sustainable and concerning with respect to wider markets.
Of course, this is not to suggest that the exchange of fire between Middle Eastern powers has not contributed to this week’s strengthening of the Dollar. It has. Rather, I suggest the direct effect is more limited than many claim and the effect of the conflict upon most markets would be best analysed in reference to the rally within key commodities that will drive up the cost of production. If this is correct and the adjustment in cross asset pricing is more the result of shifting rate expectations, we may find the volatile headlines surrounding conflict in the Middle East have less of on an impact upon markets than many would be expecting to date.
Discussion and Analysis by Charles Porter
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