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How inflation could sink stocks, rally US dollar

As markets adjust to shifting interest rate expectations, inflation data could be key to determining the fed's next move. Find out how.
Source: Bloomberg
Picture of Frank Kaberna
Frank Kaberna
Director of Strategy, Chicago

Data current as of 2/8/2024

Key points

  • US dollar up more than 5% year-to-date: (0:25)
  • S&P 500 traded all-time highs: (2:11)
  • Inflation bouncing between 3-4%: (3:15)
  • Core inflation sticky around 4%: (4:34)
  • Higher inflation, higher rates: (5:39)

Inflation data critical for US dollar, rates

Inflation data at the start of 2024 is shaping up to be a critical determinant for the stock market, interest rates, and the value of the US dollar (USD). USD's performance, particularly against the Japanese yen (JPY), has been remarkable, with a significant uptick of over 5% year-to-date. USD/JPY has approached 30-year highs, nearing the 150.00. This movement suggests that the market is anticipating inflationary pressures which could influence the Federal Reserve's monetary policy decisions.

The strength of the dollar often correlates inversely with the stock market. However, the current landscape defies this trend as the S&P 500 Index (SPX) continues to thrive, hitting new all-time highs and boasting a surge of over 25% since the beginning of 2023. This bullish stock market behavior is concurrent with robust corporate earnings among the heavily weighted stocks within the S&P 500.

The interplay between the dollar, interest rates, and the stock market is complex. Historically, a strong dollar and rising interest rates have been associated with a bearish stock market due to increased borrowing costs and reduced global competitiveness for US companies. Nevertheless, the recent alignment of a strong dollar, increasing interest rates, and a bullish stock market indicates that investors are confident in the underlying strength of the economy and corporate performance.

Investors are closely monitoring inflation as it remains above the Fed's long-term target of 2%. Headline inflation has been fluctuating, while core inflation, which excludes volatile food and energy prices, has steadily remained around 4%. The persistence of inflation above target levels could lead to a reassessment of the anticipated rate cuts by the Fed. The futures market is currently pricing in a decrease in the Fed funds rate to around 4% by the end of the year (CME FedWatch tool), which would require multiple cuts from the current level.

However, should inflation resurge, the Fed may be compelled to either delay rate cuts or potentially increase rates, surpassing the current 5% level. Such an outcome could bolster US dollar even further but might introduce volatility and downside risk to the stock market, which has acclimated to high but stable interest rates.

Reviewed by:
Glen Frybarger
Senior Content Strategist, Chicago

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