Mike Dolan

LONDON, (Reuters) – Wasn’t rising inflation meant to weaken the U.S. Dollar?

However, this week saw the reverse. The news that the U.S. had experienced a surprising rise in inflation and expectations of inflation to be at their highest level in many decades sent the dollar skyrocketing against all currencies.

As sterling and the euro, which account for 58% and 12% of the index, fell to their lowest levels in 2021, the dollar’s major index soared to the top.

Some people found this to be absurd.

The long-running belief is that Fed money, which seems to be endlessly created by Fed bonds buying, will ultimately fuel inflation and destroy the greenback’s position as the central currency of the international financial system.

Higher consumer inflation is bad news for any currency. It means that people are able to buy less goods and services. Inflation and spiralling costs have made national currencies useless in the past.

Since the 1950s, fear of “dollar debasement” has been a common theme among gold bulls. Many have demanded a return back to the gold standard since its abandonment 50 years earlier. Recent years have seen cryptocurrency advocates take up the cause.

However, bitcoin and ethereum’s failure to be excited about Wednesday’s U.S. Inflation shock has highlighted just how weak the case for crypto buying as an inflation hedge.

Even though gold gained this week, the dollar is still in the red for the rest of the year. Fed critics such as Peter Schiff of Euro Pacific Capital, longtime gold lovers, are left wondering why the dollar is rising.

On Wednesday Schiff tweeted, “Today’s dollar rally does not make sense.” “The dollar doesn’t have to lose purchasing power as fast than it is expected. This does not make it more valuable.

What’s the answer?

It’s not all that important. Foreign exchanges mean that even if there is doubt about the Fed’s faith, any loss in credibility will only matter if the central bank does more or less than the other one.

It is even more interesting to consider where U.S. rates of interest and inflation will be relative to major peers in the next year.

DOLLAR IN YOUR POSKET?

As the inflation data showed, the gap between the dollar and euro was able to increase the year-end interest rate in favor of dollars. This led to the global pivotal currency/dollar pair sliding this week to the lowest point since July 2020. In just three weeks, it has risen by almost 20 basis points from 0.9% to 0.9%.

It is expected that the Fed will raise policy rates at least twice next year. The Fed could begin raising them as early as July. Even though the European Central Bank doesn’t have a smaller rate hike price, ECB officials insist it is highly unlikely that they will increase their rates next year.

The question of whether these rates premiums are able to cover anticipated inflation differentials remains unanswered. These rate premiums seem less confident if you look at them over a 1 year horizon, however they appear to easily cover risk over a 5-10 years view, as evidenced by relative inflation swaps.

Even more important, the U.S. economy data surprise consensus forecasts are more positive than the deeply negative surprises still seen in the Euro zone. Actually, since October 2013, the difference between U.S.-Euro economic surprise indices that Citi has compiled is greater in favor of the United States.

Schiff and other Fed critics doubt that the Fed would tighten as much as the market thinks. However, mainstream investors are more confident in the Fed’s response next year. There is more scope to price those expectations higher than for central banks.

Leander Galli, senior portfolio manager at Amundi’s global fixed income team, thinks the market is neither fully priced yet for higher U.S. inflation longer-term nor for the degree to which the Fed will act to contain it.

“The Fed must move sooner than it waits,” says the Fed.

Are spiky inflation and other signs of an impending ‘debasement,’ or just a signal that there are more lucrative returns to be had?

You will find endless arguments.

The only thing it recalls is the often tedious U.S. Treasury debate on its presumed “strong dollar” policy. It is an ephemeral mantra that “a strong Dollar is in U.S. Interests”. Former Treasury Secretary Robert Rubin used this phrase in the 1990s in order not to answer questions regarding whether Washington was attempting to weaken the dollar for trade advantages.

Subsequent Treasury Secretaries frequently argued over the words – sometimes unwisely nuance the statements around whether they simply meant a strong Dollar in your pocket through low inflation or strength in world currency markets.

At least this week it’s the latter.

(by Mike Dolan. Twitter (NYSE::): @reutersMikeD. Editing by David Clarke, Steve Orlofsky