The dollar weakened against major currencies and European stocks hit record highs as traders bet on the US central bank looking through signs of rising inflation to keep interest rates close to zero.
The dollar index, which measures the greenback against a basket of trading partners’ currencies, lost 0.2 per cent on Tuesday to trade around its weakest level of 2021 so far. Over the past year, the index has fallen more than 10 per cent.
Sterling pushed 0.3 per cent higher against the dollar to $1.4199, around its strongest level since February. The euro also gained 0.3 per cent to $1.2246, its best level since January.
“The belief that US inflation is transitory has become an extremely consensus position,” said John Roe, head of multi-asset funds at Legal & General Investment Management.
In equity markets on Tuesday, Europe’s Stoxx 600 index rose 0.3 per cent, heading for a new all-time high. London’s FTSE 100 was flat, with the exporter-heavy index weighed down by sterling’s gains against the dollar. The Swiss Market Index also rose 0.6 per cent to a new record.
Headline consumer price inflation in the US hit 4.2 per cent in the 12 months to April, the biggest rise in 13 years and more than double the Federal Reserve’s target of 2 per cent over time.
The Fed viewed the jump as a temporary surge related to supply and demand imbalances, however, as industries shuttered by coronavirus last year reopened. And while central banks have used higher interest rates to control inflation since the early 1980s, Fed chair Jay Powell has taken the world’s most powerful rate-setter in a new direction by explicitly tolerating transient price rises instead of raising borrowing costs and risking a slowdown in the post-pandemic economy.
“The market has pushed expectations for Fed rate hikes further into the future,” said Solita Marcelli, chief investment officer for the Americas at UBS wealth management. “This supports our view for US dollar weakness.”
Economists surveyed by Bloomberg expect that US personal consumption expenditures, the Fed’s preferred measure of inflation that excludes more volatile components such as food and energy, rose 2.9 per cent in April, year on year.
But the five-year forward inflation rate, a market measure of price rises over time in the US, has dipped to 2.24 per cent after climbing as high as 2.37 per cent earlier this month.
The belief that inflation, which over time erodes the returns from the fixed interest paid to bondholders, will be temporary has supported prices of US Treasuries in recent months. The yield on the benchmark 10-year Treasury fell by 0.02 percentage points to 1.591 per cent on Tuesday, after approaching 1.8 per cent when inflation jitters were stronger in the first quarter of this year.
China’s CSI 300 closed 3.2 per cent higher as the outlook on US interest rates took pressure off borrowers in emerging markets.
Brent crude, the international oil benchmark, slipped 0.4 per cent lower to $68.23 a barrel.