Dollar Tight Range to Be Tested by GDP and Fed’s Preferred Inflation Read
There are a number of factors that will determine the future of the US dollar. These include Global factors, GDP growth, and Core PCE price indexes.
GDP growth
The dollar begins the week close to year-lows. Yet it will be a tough test of the consensus view that the Fed’s preferred inflation reading is still above 2 percent. This will be the last key piece of data before the Fed’s meeting next week.
The latest Fed report showed that the core PCE price index rose to a modest 4.4% in Q4. But this still remains well above the committee’s longer-run target of two percent.
A couple participants noted that risk to the inflation outlook was becoming more balanced. Those risks include persistently tight financial conditions and the possibility of a recession. Still, the economy should see moderate growth in the second half of 2022.
Participants generally agreed that it was necessary to maintain a restrictive monetary policy stance until the path toward 2 percent was clearly evident. In the meantime, they noted that recent indicators indicated a moderating pace of production and that supply bottlenecks were starting to ease.
Overall, the economy continues to benefit from government stimulus, as spending on goods has increased. The effect of these policies was particularly noticeable in housing and interest-sensitive sectors.
Core PCE price indexes
The dollar started the week in a narrow range, but is likely to face tough questions about its future path from the Federal Reserve. GDP and the Fed’s preferred inflation gauge will be key factors in the week ahead.
Economic data released over the weekend suggests that the economy continued to grow in the fourth quarter. The unemployment rate remains low, and recent data suggests modest growth in spending. But inflation remains elevated.
Consumer price inflation remained high, although it eased in the last month. Inflation compensation measures implied by Treasury inflation-protected securities declined over the period, suggesting that lower inflation data may have contributed to this decline.
A preliminary estimate of the staff’s common inflation expectations index, a combination of information from numerous indicators, edged down in the fourth quarter. It also indicates that inflation is expected to slow over the next two years.
While core prices have been back above 5 percent for the past few months, they are still below the 5.4% peak they reached in February of 2022. Nonetheless, core price inflation is projected to remain below the Fed’s 2% target through at least 2023.
Expected volatility in the US Dollar
The expected volatility of the US Dollar has not been this high for more than two decades. It is now the highest versus all other major currencies. However, investors expect it to remain strong, which may lead to bouts of instability.
In her recent Global Investment Committee Weekly report, Lisa Shalett outlines a number of reasons to watch for dollar volatility. These include a potential material shift in policy from the Federal Reserve. As she points out, “the market will be much more sensitive to a material change in policy than to a minor deterioration in the economy.”
In addition, the Federal Reserve is aggressively hiking interest rates, which are boosting the value of the dollar. As a result, the dollar has become a safe haven in volatile markets. Nevertheless, investors should consider incorporating some other assets into their portfolios. For example, you could invest in a basket of international assets that are less correlated with the dollar.
Another option is to purchase VIX futures. This can help to hedge your risk against a broad market decline.
Global factors on the US economy
The United States economy is one of the largest and strongest in the world. It has access to abundant natural resources and a large and productive workforce. It also features a technologically advanced services sector. In addition, it has a strong manufacturing base.
Although there have been some economic problems, the US economy continues to be a leader in many fields. However, it is still facing significant challenges in the future.
One of the major issues that the economy faces is its current account deficit. This is a problem caused by the nation’s trade deficit. Since the 1990s, the trade deficit has widened substantially. This has led to a decline in corporate profits. Furthermore, the deterioration of the trade deficit has hurt manufacturing jobs.
Another major issue for the economy is the growth of income inequality. Although the labor market has largely recovered, wages have remained stagnant.
Another challenge to the economy is the rising costs of pensions. High debt levels are also a concern.