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US Dollar Supported by Inflation but "Should be Trading Higher" on Federal Reserve Rate Hike Talk

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The USD has endured further declines as recent inflation data doesn't go its way, but can members of the US Federal Reserve support the currency by keeping alive the prospect of 2016 rate rise?

Investors continue to shed exposure to the US Dollars and over the past 24 hours we have seen the currency move lower against all of the major currencies. 

The USD lost approximately 1% of its value versus the Yen, Sterling, Swiss Franc and New Zealand Dollar.

The Dollar Basket fell to its lowest level since June 23rd.

The latest inflation statistics from then US showed price growth moderating in July, in line with consensus estimates. Typically soft inflation data would be negative for the USD as it would imply the US Federal Reserve need not consider raising interest rates to stem inflation.

However, it is clear markets were worried that the fall would be greater than the number that transpired.

The Dollar rose as a consequence, with a dollar index increasing to 94.85 from 94.38, in the five minutes following the announcment.

Inflation in July came out at exactly the levels analysts estimated, showing a slight slowdown to 0.9% from 1.0% on an annualised basis, and to 0.1% from 0.2% on amonthly basis.

However, it must be noted that Housing Starts data were also released and they showed a rise of 2.1% on a monthly basis in July, smashing expectations of -0.8% fall.

The Fed and why the Dollar "Should be Trading Higher"

Looking ahead, the US Federal Reserve is on the agenda with the release of the minutes to the July 26-27 meeting being released.

The minutes will provide further fodder to traders who are betting on Dollar direction according to the timing of the next interest rate rise at the Fed.

Ahead of the release we have had some pro-USD talk coming from Fed Presidents Dudley and Lockhart.

Both warned that the market is underpricing tightening and rates could rise this year.

Dudley who is a voting member of the FOMC went one step further to say that a hike in September is possible.

"There's no ambiguity in where stand on monetary policy and for this reason, the Dollar should be trading higher," says Kathy Lien, Director at BK Asset Management

Lien believes that based on the price action of the Dollar investors are not buying what Dudley and Lockhart are saying.

Rather, they are looking at last week's soft retail sales report and today's stagnant inflation report and using them as arguments for why rates will remain unchanged this year. 

However Fed fund future traders have been swayed by the Fed Presidents with the market now pricing in a 51% chance of a 2016 rate hike up from 45% yesterday.

"So the only explanations for the weakness in the dollar aside from the skepticism of forex traders is positioning and the technical condition of the Dollar," says Lien. 

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