The United States' April core inflation was exactly three times higher than the forecast (+0.9% against +0.3%). It has an annual growth of 3.0%, which is the maximum since 1996. The overall inflation increased by 4.2% y/y, and the key question for markets now is how much of the increase in April is due to temporary one-time spending and how much reflects more persistent inflationary pressures?
As for demand, there are at least three factors that need to be taken into account. The reaction of the US financial authorities to the COVID-19 pandemic led to the fact that the disposable income of the population increased by 32% yoy in Q1 2021. Such a level of stimulation has never been observed before.
As the pandemic led to severe restrictions in the service sector, the main demand supported by incentives was for goods, which in turn, led to a strong increase in investment in the production of equipment for working at home, ranging from work tools to electronics. Therefore, a surge in consumer demand and, as a result, an increase in core inflation is a completely objective matter.
It's more interesting with prospects. It is already known that the growth of production prices and raw material prices will fall in the consumer sector sooner or later, if it is not caused by short-term or one-time events. It is this very factor that will be considered by market participants to understand whether the current inflationary surge is temporary or still has a long-term trend.
So far, the situation looks like the consumer boom will not be satisfied at least in the next few months. The increase in metal prices is also due to a reduction in supply. As an example, copper exports from Chile and Peru sharply declined last year, as the response to the pandemic led to job cuts in mines. Similarly with iron ore in Australia and Brazil.
ISM reports showed that there is a strong growth in demand with a simultaneous decline in stocks, the run-up between these two indicators is the highest in the entire history.
It is clear that it is impossible to close this gap quickly, that is, demand will surpass supply for at least several months. This is an additional factor in the growth of inflation.
Apparently, we will not see a decline in inflation in the upcoming months, but continued growth. As the COVID-19 restrictions are lifted, the services sector will experience an explosive growth in deferred demand, and since the Fed is taking a break, this demand will not be limited by anything, given the volume of stimulus globally.
Several conclusions can be drawn from all of these. First, the US dollar is unlikely to start strengthening in the coming months. Second, the demand for commodity currencies will increase, which will show serious growth in the summer months.
EUR/USD
Europe gives no reason to revise the overall long-term forecasts. Industrial production in March is slightly worse than expected, but overall, the recovery rate is higher than in the UK due to Germany. The ZEW business sentiment indices in both Germany and the euro area as a whole significantly exceeded forecasts in May, indicating business confidence in the economic outlook as economies open up.
The downward correction should be used for purchases. The targets remain the same – the nearest is the level of 1.2243, followed by the local high of 1.2350. The resistance of the euro is located at the level of 1.23, where the middle of the upward channel passes.
GBP/USD
Most of the indicators released on Wednesday exceeded forecasts. There is an increase in industrial production by 3.6% y/y against the forecast of 2.9% and an improvement in the trade balance. Based on the calculations of NIESR, GDP growth is in line with forecasts, and it is expected at 4.7% in Q2.
The markets ignored Scotland's referendum, as much more important is the fact that the UK is covered by a wave of deferred demand. The pound confidently made a pullback on Wednesday on the wave of US inflation data. However, there is practically no reason for it to reverse down in the long term.
The pound failed to consolidate above the resistance level of 1.4140/50, but it will most likely find support near 1.4050 or 1.3970/90, after which the growth will resume. The target is still the level of 1.4370.