Scared of the latest inflation report? It’s time to sell the US dollar

Yesterday’s hotter-than-expected inflation report in the United States triggered a massive move higher in the US dollar. Also, stocks dived as Wall Street posted the biggest one-day percentage drop in two years.

Inflation surprised to the upside. In August, consumer prices increased by 0.1% MoM vs. -0.1% expected. Also, core consumer prices, which do not include energy prices, rose by 0.6% vs. 0.3% expected.

Are you looking for fast-news, hot-tips and market analysis?

Sign-up for the Invezz newsletter, today.

As such, the YoY inflation climbed to 8.3%, while the market expected 8.1%.

It may not look like a big increase, but the markets were taken by surprise. After the report, Fed swaps showed a terminal rate for the Fed’s funds above 4.15% at the start of 2023.

So the dollar surged, and stocks tanked.

However, for contrarian traders willing to take the other side of the dollar, here are two reasons to fade the move:

• Shelter CPI is a lagging indicator
• DXY failed to climb above 110

Shelter CPI is a lagging indicator

Most of the upward surprise in yesterday’s report came from shelter, which went up by 0.7%. However, this is a lagging indicator, meaning that the data may have been distorted.

Nevertheless, the Fed will have no choice now but to raise the rates at the next meeting by 75bp. Some argue that a bigger rate hike is needed, but that is unlikely.

More likely, more officials will project higher rates in the quarterly economic projections to be presented next week. Therefore, a 75bp rate hike is the base case, and it was already priced in before the inflation report was released.

DXY failed to climb above 110

The dollar index (DXY) shows the dollar’s strength or weakness against a basket of currencies, such as the EUR, GBP, or CHF. It recently climbed above 110, but failed to hold above.

Moreover, two bearish signs appeared on the daily chart – a rising wedge pattern and a bearish divergence with the RSI or the Relative Strength Index.

All these call for caution. Indeed, inflation keeps rising in the United States, but it is not a surprise anymore. Interest rates are already elevated and on track to rise some more.

A 75bp rate hike at next week’s meeting follows other large hikes. Therefore, tightened financial conditions might already be priced in, and dollar bulls should be cautious at current levels.