With US inflation coming in much higher than expected, market participants are moving towards a position of expecting not just 75 basis points, but a 100 basis points hike by the Federal Reserve in July. This will have a significant impact across major markets and trading strategies.
- Pricing for an ever more aggressive Fed tightening is positive for the US dollar and negative for risk assets
- We retain our strategy to buy the USD into weakness
- Selling indices and commodities into strength is also our preferred strategy
The impact of higher US CPI
US CPI came in well above expectations yesterday. The headline CPI increased to 9.1% from 8.6% which was a significant upside surprise to the 8.8% expected. Core CPI was also higher than expected at 5.9%. Although this was down from the 6.0% in May, it was much higher than the 5.6% expected decline.
Inflation remains hot at 40-year highs. The Federal Reserve needs to get a hold of it. Previously, markets had expected a 75 basis point hike in July. The FOMC members had all spoken of this as being likely. However, markets are increasingly pricing for a 100 basis points hike.
According to the CME Group FedWatch tool, Fed Funds futures suggest that the market probability of a 100 basis points hike at the end of July is well above 80% now.
Traders will be keenly watching any remaining Fed speeches for any clues of more aggressive tightening this week in front of the FOMC Blackout that starts this weekend. However, the momentum for a 100bps hike is considerable now in the market and will remain until the FOMC meeting on the 27th July.
Quite how the Fed responds to this will be interesting. In June there was a hawkish move following the upside surprise in the June CPI. It is likely to want to front-load hikes this year. Interest rate futures are still pricing for the terminal rate to be c. 3.75%/4.00% by the end of 2022 before the rate cuts kick in during Q1/Q2 2023 back towards the 2.50% area.
Our preferred trading strategies remain broadly the same
To play this increasingly aggressive interest rate tightening of the Federal Reserve, we continue to prefer:
- To trade for USD strength – buy USD into any near-term weakness
- Sell commodities into strength– sell oil, and gold to also decline
- Sell indices into near-term strength
We still like USD longs
The USD has been strong for more than 12 months. However, whilst the Federal Reserve is aggressively tightening rates in the coming months, we still believe that there is further to run in USD longs.
The Dollar has accelerated higher in recent weeks and remains strong. However, there is little resistance of any significance (the Dollar Index is at 20-year highs).
The key question is whether there is a pullback. We look to EUR/USD trading around parity for that. For several days, parity has been tested but held. There may be a near-term technical rally to defend parity (maybe up to 1.0200/1.0350, but the ongoing USD strength is likely to prevail in the end and breach the psychological 1.0000 support. Moves towards 0.9800 could easily be seen if the floodgates of parity are broken. With EURUSD at 20-year lows, there is no real support, with the next low of any note around 0.9600.
Commodities also look negative
The fear of recession and USD strength has significantly weighed on commodities in recent weeks. Base metals have fallen sharply, but even oil has fallen hard. A close on Brent Crude oil (UKOUSD) below $98.00 would be the lowest since February and complete a big top breakdown. This could open the way towards $95 and possible $90 in due course. Near-term rallies are increasingly failing at lower levels, leaving resistance at $108/$110 now key.
We also look towards further downside in Gold (XAUUSD). The price has broken below support at $1722 this week and now looks on course for a move back towards the key 2021 lows at $1676. We look to use near-term rallies as a chance to sell. Initial resistance is $1745/$1752 with more considerable resistance at the $1785/$1800 area.
Indices are posting bull failures again
We have talked recently about the potential for recovery in equities, but with the resistance bands holding firm, once more these near-term rallies have faltered. On Wall Street, the S&P 500 futures (SP500ft) have failed in the resistance band 3875/3950, broken the recovery uptrend and are now testing the 3741 key higher low. Below that would open the 3639 June lows again, but given the strength of the downtrend, this may also be broken in due course. Rallies towards 3835/3875 now look to be a chance to sell.
It is a similar case over in Europe too. Indices are again re-affirming their negative configurations where rallies as a chance to sell. On the German DAX (GER40) we see the trend lower in the past month, with a series of negative candles again. We look towards a retest of the early July low at 12,375. The longer-term chart also suggests that if 12,375 is broken the way towards 11,330 (the next key support from October 2020) would be on. Near-term rallies into 12,800/13,000 resistance now look to be a chance to sell.
This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.