Diverging inflation stories prop up dollar, for now

The theme of the week has been one of diverging inflation stories which have helped boost the US dollar. These divergences came not just between economies (hot inflation data in the US and cold in the UK, for example) but also within economies, with mixed messages from core US CPI and PCE inflation data. But the reaction to US inflation data looks misguided to us – we think the Fed is focused on PCE inflation, which looks on track to hit 2% by May. As investors come around to our view and price Fed rate cuts back in, we think the dollar will hand back some of its recent strength. That said, we don’t expect the Fed to cut rates until May; so, a turnaround in investors' rate expectations might not be imminent. And, in the interim, we expect strong relative demand for US equities to persist and support flows into the US dollar. So, we wouldn’t be surprised if the greenback continued to grind higher for a bit longer.