Market Overview

April inflation data in the United States that was released on May 10 had a serious impact on the market. The sigh of relief was quite explainable as no evidence of extra money poured into the market by the Federal Reserve (Fed) in March to save U.S. regional banks was spotted in inflation figures.

Instead, April Consumer Price Index (CPI) dropped to 4.9% beating consensus, and lower than the March figure. Declining WTI crude prices, that fell from $83.5 per barrel to $73.8 per barrel during April, certainly contributed to the slow down, but Core CPI, which excludes volatile food and energy prices, also dropped to 5.5% from 5.6% a month before. This highlights the trend of a true slowdown of inflation facilitated by the Fed in particular.

The money that was used to pay off deposits of the collapsed U.S. regional banks remained inside the banking system and moved to large banking institutions, instead of spilling over into the consumer market. The Fed is vigorously removing this extra funding that it has provided to support the banking system in March, reducing its balance sheet. It surged to $8.74 trillion on March 8 from $8.34 trillion just a week before, and fell to $8.50 trillion at the end of April. With this in mind, it could be expected that the recent April repercussions in the American banking sector would not further amplify inflation.

More importantly, real interest rates in the United States have become positive, a situation that has not been seen in the last two years. Interest rates at 5.25% are above inflation, which prompts the Fed to feel it has done most of its job regarding inflation. Moreover, it may eventually go even further to decrease its interest rates as they are close to U.S. 10-year Treasuries yield at 4.8%. High inflation that was exceeding the yield eases servicing debt. The Ministry of Finance had relatively cheap money to repay the debt. But now the situation has become slightly different.

Rising U.S. debt and struggle over the debt ceiling, continuous to trouble the banking sector that suffers from high interest rates, depreciating assets, and is nearing a recession fostered by expensive borrowings that limits margins, demand, and production which has already prompted the Fed to decrease its interest rates this autumn.

Paradoxically, such circumstances have not led to a plunge of the Greenback. The U.S. Dollar index retreated to 101.0 points from 101.5 points before the data was released. But it didn’t go further below this April’s lows at 100.4 points despite inflation being higher and the Fed’s interest rates being lower back then with less reason for a decline.

The major reason for such a straight line of the Dollar may be found in emotional and largely exaggerated expectations of the U-Turn in the Fed’s monetary policy that was seen before its last meeting in early May. So, a strong support level for the DXY at 100.4 points may not be crossed in this regard before a serious decline of interest rates is initiated by the Fed. Meanwhile, an upside correction for the DXY may rather be an outcome as most of the downside factors have lost their strength.

An unexpected drop of CPI in China to 0.1% from 0.7% in March has suddenly hit the market. The Producer Price Index (PPI) has dropped further into negative territory to -3.5% from -2.5% a month before. This reading had a clear negative impact on the global economy as China has very low inflation. Such a slowdown in prices means a dramatic decline in demand both from consumers and producers that undermines economic growth of China. This in turn is leading to a deteriorating global demand as China is a huge part of the global economy.

This increases recession risks not only for the U.S., but also on a global scale. So, the Dollar is acting as a safe haven asset despite a possible interest rate decline. This enables the DXY to recover to 101.9 points. Even the increase of the interest rates by the Bank of England to 4.5% from 4.25% was unable to deter the upside sentiment for the Dollar as it was largely expected. The same could be said about Initial Jobless Claims at 264,000 that missed expectations of 245,000, and was worse than the previous 242,000 figure.

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