US inflation data was much higher than expected with the headline rate at the highest level since 2008.

US inflation data was much higher than expected with the headline rate at the highest level since 2008. US bond yields moved higher after the data amid a shift in Fed funds futures.

Equities were undermined by the higher inflation print amid concerns that low US rates would not be sustainable. The US S&P 500 index declined over 2% at the close with losses in Asian markets.

After initial volatility the dollar strengthened after the inflation data as higher yields provided net support. EUR/USD dipped below 1.2100 amid the US correction, but bounced from lows. Despite resilience, Sterling was subjected to a correction as risk appetite faded with GBP/USD near 1.4050. Commodity currencies retreated sharply amid the US dollar recovery and higher yields.

Relatively tight ranges prevailed ahead of Wednesday’s New York open with inevitable caution ahead of the US inflation data. The dollar edged higher with a covering of short positions and EUR/USD retreated towards the 1.2115 area. Recovery expectations provided some underlying Euro support.

The EU Commission increased the Euro-zone 2021 GDP growth forecasts to 4.3% from 3.8% previously and the 2022 outlook was also upgraded. The Commission expects a significant easing of coronavirus restrictions during the second half and the EU also announced that budget rules would be suspended until the end of 2022.

US consumer prices increased 0.8% for April which was substantially above consensus forecasts of 0.2% and the strongest monthly increase since August 2008. The year-on-year increase jumped to 4.2% from 2.6%, also well above market expectations of 3.6% and the highest reading since October 2008.

Underlying prices increased 0.9% on the month compared consensus forecasts of 0.3% with the year-on-year rate at 3.0% from 1.6%. This was the highest core reading since the beginning of 1996. There was a sharp increase in energy services prices on the month and there was a 10% surge in the price of second-hand vehicles to give a 21% annual increase. There were also strong price increases in commodities on the month.

The dollar jumped higher on the data with EUR/USD dipping to lows near 1.2075. The dollar quickly retraced gains, but regained traction later in the session, especially with sharp losses for commodity currencies and EUR/USD retreated again to 1.2070. Markets attempted to stabilise on Thursday with EUR/USD around 1.2075. Inflation developments will remain a key element in the short term with the producer prices data due later in the day.

US Treasuries dipped sharply in an immediate reaction to the US inflation data. The 10-year bond yield strengthened to 1.65%, but there was a quick reversal and USD/JPY strengthened to around 109.20 before also fading quickly as volatility increased sharply.

Fed Vice-Chair Clarida stated that inflation was likely to increase further in the short term before moderating later in the year. He reiterated that the inflation rise above 2.0% is due to transitory factors. There was, however, a slight shift with comments that he would take it very seriously if longer-term inflation expectations started to move higher. He also noted that the central bank does not have infinite tolerance for inflation.

Fed Funds futures indicated an 80% chance of a rate hike by the end of 2022.

Bond yields moved sharply higher again towards the European close and USD/JPY strengthened to around 109.40. The dollar maintained a stronger tone into the New York close as yields remained higher with a peak around 109.80. Bank of Japan Governor Kuroda stated that the bank is prepared to extend pandemic relief beyond September if needed. Risk conditions attempted to stabilise, curbing potential yen demand on safe-haven grounds, and USD/JPY was held around 109.75.

Overall confidence in the UK recovery outlook was sustained following the batch of data releases. The growth data did not dampen expectations of a strong recovery in the economy while the trade data and a net recovery in EU exports also lessened the immediate risk of selling on the grounds of Brexit concerns.

In this environment, Sterling was able to maintain a firm underlying tone. The UK FTSE index also outperformed in global terms which underpinned the UK currency.

Sterling did retreat against the dollar following the US inflation data, but the Euro retreated to 1-month lows.  The UK currency was undermined by higher US yields and weaker equities. GBP/USD dipped to near 1.4050 against while GBP/EUR retreated from highs at 1.1680.

Bank of England chief economist Haldane maintained a hawkish stance on the outlook for growth and inflation and continued to back a reduction in asset purchases, although he will leave the bank next month. The RICS house-price index strengthened to 75% from 59% previously and the highest reading for 40 years.

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