The most important data release for dollar pairs could be on Tuesday with the release of PPI figures for March from the US. As traders try to figure out what will happen with interest rates in the turbulent circumstances, gold prices could also fluctuate in the aftermath of the data.
One of the main reasons that the war in the Middle East is affecting markets so much is the worry that higher fuel prices will raise overall inflation. We’re already seeing higher prices at the pump as retailers scramble to get ahead of increases in wholesale prices of gasoline and diesel. But, there are two main issues here that are relevant to forex markets. The first is that the transfer of costs is not the same depending on geography, which can lead to variations in currencies. And secondly, just how much and how fast higher energy costs filter into the broader economy will be determinant for interest rates.
Increasing Optimism For a Fed Rate Cut
Markets have reacted positively to the ceasefire between the US and Iran, and have become only slightly nervous after the first round of talks didn’t deliver the desired result. In the longer term, investors are growing increasingly confident that the war will be over soon, which is reflected in Treasury futures. US bonds are the go-to safety play, and they reflect the odds the market is placing on when the Fed will cut or raise rates. At the most intense portions of the war, markets were raising expectations for a rate hike.
Now, futures indicate that the market is gaining confidence that the next move by the Fed will be a cut. Though, still a strong majority (75%) suggest no change in policy by the end of the year, the dissent is almost entirely to the downside. This is sufficient change towards dovishness to have weighed on the dollar in recent days, as the index falls to the lowest level it has been since early in the war.
“Looking Through” vs Economic Pressure
The thought is that if the war is over soon and crude prices come down, then the bump in inflation will be temporary. This will allow the Fed to “look through” the headline CPI number and focus on the core reading. If the US economy continues to show weakness like it did in Q4, then traders could expect the Fed to resume its easing. This would likely weigh on the dollar, but support gold.
What could add additional weight on the dollar relative to other currencies is that major central banks like the BOE and ECB might not be able to “look through” inflation as easily. The US is a main oil exporter, meaning high crude prices bring an influx of dollars. The EU is an energy importer, mostly from the US, meaning an outflow of Euros as long as the prices remain high. This could mean the ECB is forced to remain hawkish even if the war ends, but importers remain uncertain about the reliability of supplies.
What the Market is Looking For
Traders will be looking for signs that higher energy costs are filtering into the broader economy through higher purchasing prices. If PPI rises substantially already in March, this could mean that core inflation might be affected sooner than expected, and leave the Fed more hawkish. On the other hand, softer PPI figures would mean less inflation pressure and more room for the Fed to potentially ease later in the year.
The consensus is for the monthly US March PPMi to jump to 1.3% from 0.7% a month earlier. However, excluding food, energy and trade, the monthly rate is anticipated to decline to 0.4% from 0.5% in February.
