Fears of Inflation Eased for Now

Markets are still slightly shocked after the Federal Reserve has change its position towards earlier hike of interest rates and high inflation forecast. Just a month ago the U.S. monetary regulator was not even concerned by galloping prices. And now the Chairman of the Fed Jerome Powell sees inflation might overshoot even Fed’s forecast at 3.4% this year.

A bit of a twist to the overall picture was added by Fed’s decision to increase the interest rate of reverse Repo, tighten requirements on excessive bank reserves and revised trajectory of interest rates hikes on top of this. 13 of 18 FOMC members are now seeing a possibility of an interest rate hike in 2023 while a month ago there was no suggestion of it. Such alterations came just after two months of rallying inflation. And how the situation might change in a month time when inflation in June jumps to 5.5% or even to 6%? Anyway the process of tightening the monetary policy has now started.

The most intriguing event of this week have already passed and markets reacted quite positive. The S&P 500 broad market index resumed climbing and posted new all-time highs, crude prices jumped to two years highs while the U.S. Dollar remained stable against the basket of other world’s major six currencies.

The President of the European Central Bank Christine Lagarde made everything possible for investors to move markets up. After the meeting of ECB Board Mrs. Lagarde immediately devalued all market fears of high inflation leaving all stimulus measures unchanged, including the PEPP bond purchase program. Moreover, she indicated the program might be expanded to compensate seasonal lack of liquidity.

Concerning inflation Mrs. Lagarde said it is far from readings ECB wants to have before moving to a normalization of the monetary policy. Her rhetoric was extremely dovish soothing any possible strong reaction on the super high May inflation readings in the United States. The CPI index in May rose to 5.0%, according to U.S. Bureau of Labor Statistics, a highest since August 2008.

Despite such terrifying high inflation readings market are not taking it seriously so far as investors are looking at the reaction of two major central banks and Mr. Powell and Mrs. Lagarde are keeping their brains on ice. But, how long this silent race of the nerves would continue, would Mr. Powell remain unflappable after the next Fed meeting next Wednesday or could he signal that the Fed might finally taper its massive monthly $120 billion bond purchase program. Nevertheless, market would sound positive until then.

The S&P 500 broad market index has not corrected itself to 3160 points as was expected making just one attempt when it slid lower to 4205 points. However, this dip was quickly bought returning the index above 4220 points. With such strong support we could not expect any correction to happen this week. Moreover, we should be prepared for new record highs next week before the scheduled Fed meeting.

Crude prices were more volatile with Brent crude hitting two year highs at $72.80 per barrel thanks to the unexpected strong contraction of crude reserves by 5.24 million barrels in the United States. OPEC positive outlook for crude demand in the second half of 2021 also supported prices. A short downward spike at the end of Thursday might be a signal of possible slowing down of crude prices rally.

Gold has performed no significant price movements this week finishing it in a narrow trading range of $1890-1900 per troy ounce. It is possible that gold prices would continue in this manner before Fed meeting next week.

The Greenback missed its chances to strengthen. The EURUSD remained near 1.21850 level. It would be irrational to expect the pair to reach the support at 1.20500 before next Wednesday. So, sideways movements would be a likely scenario.

GBPUSD is trading with minimal volatility around 1.41200. However, the pair has some upside potential to 1.42300. If this level would be reached, some small short positions with a target at 1.41200 may be opened.

The USDJPY is the only pair that performed high volatility this week. However, it was waning by the end of the week. The lateral movement within 109.00-109.80 range would likely remain the only scenario for the Yen for the rest of the day.