You would think strong growth would be good for commodity currencies but a hot US services sector report today has been just the opposite. Instead, it's the US dollar that's soaring while CAD, AUD and NZD sink alongside a +2% decline in the S&P 500.
While global growth is picking up, the market at the moment is focus on the central bank side and the possibility that the Federal Reserve is forced to hike rates to 6%.
For me, it comes down to a question of: How patient will central bankers be? In a normal situation, they would hike to around 5% and wait for the lagged effects of monetary policy to kick in. The context this time though is that they fell way behind the curve in 2021 and are desperate not to make the same mistake. In turn, they may be inclined to continue hiking rates to be absolutely sure that inflation is crushed.
At the same time, that raises this risks of over-tightening and sparking a reversal.
Instead, the Fed is likely to retain optionality to hike more but leaning instead on a plan to keep rates at the peak for longer, in the hope that inflation will eventually fall back to 2%. That's a reasonable thesis and I think it's enhanced by higher rate-sensitivity in many other countries so that's why I'm watching how the economies of Canada and Australia hold up. I think the rest of the world slowing would add some global slack and that could cool US inflation. It may also come with US dollar strength and we're seeing some signs of that in the past week.
For the next leg of that strength, we'll need to see a slowdown in international data.
