Interest rate cuts and the falling dollar will fuel inflation that is already above the Federal Reserve target – which may not just end the easing cycle early, it might spur a tightening cycle that no one is currently expecting.
Core CPI, which rose to 3.1% year-on-year in July, is substantially higher than the central bank’s 2% target, and will be supported by the weaker dollar.
If they account for the inflationary effect of import tariffs, then those sitting short of dollars have good reason to hedge the growing risk that expectations for easing are overdone.
Although oil has cheapened this year thanks to substantial hikes in output by OPEC and its partners, Brent crude is trading almost $8/bbl above the low reached after producers first opened the taps in April.
The disinflationary impact of cheaper oil may be offset by the dollar, which is a little weaker than it was before output was initially hiked.
What should swing the balance of risks significantly against those betting on a deeper dollar decline is the current expectation for a substantial drop in the U.S. interest rate. If expectations are met, a lower interest rate could spark a much bigger rise in inflation.
Those short of dollars may not see all the stimulus they anticipate, and could instead see an abrupt end to the easing cycle that spurs a dollar rally.
(Jeremy Boulton is a Reuters market analyst. The views expressed are his own)