Dollar Rallies While VIX Drops After CPI, What Dictates the Market’s Next Move?

S&P 500, VIX, Dollar, CPI Inflation and USDJPY Talking Points:

• The Market Perspective: EURUSD Bearish Below 1.08; Dow Range Between 34,200 and 33,200; USDJPY Bullish Above 133
• US CPI cooled for a 7th consecutive month but the pace of ‘dis-inflation’ has noticeably cooled with a tepid drop to a 6.4% headline that has bolstered Fed rate expectations
• Despite the higher rate trajectory expected for the US, the S&P 500 was steady, the VIX dropped sharply and the Dollar progressed little…now what?

This week’s top event risk has come and gone and many will be surprised by the market’s response to the update. Inflation in the US has been a hot topic over the past half year given particularly with the perceived transition from an aggressive tightening regime to a status quo path for the world’s largest central bank, the Federal Reserve. While the data speaks to a particular country’s policy bearings, a tightening of the US financial system is a guide on expectations for the rest of the world. All that said, the January update for the US CPI (consumer price index) offered up the 7th consecutive month’s deceleration of pace since the 9.1 percent peak in the June stats. That said, the market’s are forward looking and nuance matters. While the central bank’s much sought-after disinflation is happening, the pace has markedly cooled. The 6.4 percent headline year-over-year figure was higher versus the 6.2 percent expected. What’s more, the less volatile measures and some of Chairman Powell’s particular areas of concern offered up evidence that pressure may prove stickier than the Fed wants.

Chart of S&P 500 with 20-Day SMA, Volume and Day/Change in US CPI YoY (Daily)

Chart Created on Tradingview Platform

In turn, the market’s discount to the FOMC’s commitment to a terminal rate at 5.1 percent (according to the SEP) with no rate cuts expected through 2023, has all but evaporated. Fed Fund futures are now pricing in a peak rate forecast that stands at a premium to the central bank’s own views with forecast for a reduction in the rate in the second half of the year all but gone (there is -1bp difference between the June and December implied contract). For the S&P 500 and other ‘risk assets’, that would seem a problem; but there hasn’t really been a wide berth between Fed and market view to this point, so it doesn’t necessarily have to touch off panic. A look at previous CPI releases suggests that even large reductions in pace were met with temporary buoyancy before the markets swung lower. Other factors enter the picture at that point, but there aren’t many other points of genuine enthusiasm to work with going forward. A relief that the CPI wasn’t more problematic for the markets than it ‘could have been’ seems the interpretation from the VIX. That shouldn’t provide us a deep sense of relief however. Markets are already too sanguine for the picture we are currently facing in the global financial system.

Chart of VIX Volatility Index with 50 and 200-Day SMAs, 1-Day Rate of Change (Daily)

Chart Created on Tradingview Platform

Perhaps even more surprising for some traders was the Dollar’s lack of reaction to the higher Fed rate path now projected by the market itself. The actual peak rate as priced through Fed Funds futures is through August, and the implied rate is now pushing 5.29 percent. That is above the FOMC’s own 5.1 percent, but it is not unlikely that the March SEP will see that consensus shift up similar to the market’s own view. That being said, the difference between 5.1 and 5.29 percent is not that material, especially when comparing to other central banks like the ECB which has indicated that more hikes are on the horizon (FX is a relative value consideration). Seeing the DXY Dollar index struggle below 104 is not particular surprise, but what could inspire the Dollar bulls in earnest? I still believe the Greenback’s connection to ‘fear’ and its safe haven status reflects the most untapped potential. That said, should the S&P 500 drop, it could revive an underappreciated (and undervalued) aspect of the currency.

Chart of DXY Dollar Index Overlaid with Market Implied Fed Funds Aug 2023 Rate and VIX (Daily)

Chart Created on Tradingview Platform

For specific USD-based pairs, my attention is still on USDJPY. It’s struggles are just as notable on the technical side as they are fundamentally. That being said, the contrast in monetary policy is still the most disparate we will find amongst the major players – at least until the new income BOJ Governor decides to mark the end of the ultra-loose policy. Here, risk sensitive may seem an unusual consideration because the Yen is often considered a benefactor of risk aversion – owing to its carry trade unwind status. However, for USDJPY, the positive correlation to VIX is still very noteworthy. I will be watching the volatility index closely going forward.

Chart of USDJPY with 50-Day SMA and 1-Day Rate of Change, Days of ‘CPI’ Release (Daily)

Chart Created on Tradingview Platform

For top event risk over the next 48 hours, there aren’t any CPI-like events that can stand alone in terms of full scope market moving potential. That doesn’t mean, though, that we are free of sparks. In the US, the combination of US retail sales, industrial production and housing market sentiment is a good overview of economic health in the world’s largest economy. Fed speak is also fairly dense ahead, so we will see what the policymakers have to say after this past session’s CPI release. Speaking of inflation, the UK will have its go at January price pressures with a run of data at 7:00 GMT. The Sterling has absorbed warnings of extreme inflation and the FTSE 100 of recession ahead, but can it continue to overlook the pressure. Chinese policy and Australia employment are other outliers to watch as well.

Top Global Macro Economic Event Risk for the Next 48 Hours

Calendar Created by John Kicklighter