The dollar was up over 1.5 per cent against a basket of currencies on Friday, driving higher after a volatile trading session during which it jumped to a five-year high against the yen on expectations of aggressive Federal Reserve rate hikes after a spike in the US inflation to its fastest in 40 years.
Data on Thursday showed that US consumer prices surged 7.9 per cent year-over-year in February, the largest annual increase in 40 years, even before the surge in commodities prices caused by the war in Ukraine has had its full effect.
“The Russia-Ukraine conflict has added to global inflation, reduced prospects for economic growth and greatly increased uncertainty,” said David Kelly, Chief Global Strategist for J.P. Morgan Asset Management. “For the United States, the situation is less dire” than that of Europe.
“For European consumers, higher energy costs are already taking a toll. That being said, rising oil prices would likely have a significantly negative impact on the US economy,” he added.
Inflation is poised to accelerate further in the months ahead as Russia’s war against Ukraine drives up the costs of crude oil and other commodities.
To up the ante on Moscow, the US, together with the Group of Seven (G7) nations and the European Union EU), will move on Friday to revoke Russia’s “most favoured nation” status over its invasion of Ukraine, multiple people familiar with the situation told Reuters.
Stripping Russia of its “favoured nation” status paves the way for the US and its allies to impose tariffs on a wide range of Russian goods, which would further ratchet up pressure on an economy that is already heading into a “deep recession.”
The inflation data “basically indicates the Fed should be hiking rates this month, but it also indicates that they will keep going – with hikes, at least initially,” according to Rodrigo Catrill, a currency strategist at the National Bank of Australia.
That expected Fed tightening will lead to a divergence in interest rates compared to most major economies, albeit at varying degrees, and is likely to result in a significant reset globally, with the focus shifting towards inflation and away from pandemic-support stimulus and growth focus.
As a result, it brought dollar bulls out in force, with the greenback expected to maintain its strength even as other major economies would struggle to match the Fed’s faster rate hike path.
The dollar index – a measure of the greenback’s value against a basket of major currencies, was last up 1.582 per cent at 97.1760.
“You just don’t know how far the Fed is going to go because we don’t know exactly when inflation will really peak,” Ed Moya, senior market analyst at OANDA, told news agency Reuters.
While there is optimism that inflation will subside by midyear, it could get worse and lead to more aggressive Fed action, he said, adding, “you got a little bit more left in this dollar move,” he added.
The dollar hit a new five-year top on the yen on Friday, rising as high as 116.55 yen in early trade, its highest level since January 2017. The dollar is up 1.5 per cent on the yen this week, its biggest weekly gain since October.
“Our base case scenario is still for the Fed to be the most hawkish central bank in the developed world, and that should support the dollar at the margin,” Bipan Rai, the North American head of FX strategy at CIBC Capital Markets, told Reuters.
Even as growth, stagflation and recession worries have kicked in driven by Russia’s invasion of Ukraine on February 24 and the retaliatory sanctions on Moscow, which has pushed oil prices to multi-decade highs on supply concerns.
Sentiment has also suffered on worries over Russia’s war against Ukraine after talks between their foreign ministers on Thursday brought little respite in the conflict between the two countries.
“Talks between Russia and Ukraine did not deliver anything concrete yesterday, nor was there any follow up on the UAE OPEC+ noise on crude production, yet despite this, markets only retraced some of their gains of the previous day,” said Robert Carnell, Regional Head of Research for Asia-Pacific at ING.