USD Back on Top: Strong NFP and Retail Data take Markets by Surprise

Recent data releases in the US have surprised investors, with US economic growth remaining stubbornly resilient in the face of repeated interest rate increases by the Fed. But what does this mean for the markets in the mid-term?

The markets spent the first few weeks of 2023 pricing in a sustained fall in core inflation in the US, confidently betting that the Fed would start lowering interest rates in the second half of this year. Data in Q4 2022 seemed to show that US economic growth had started to slow in response to the Fed’s hawkish stance on inflation. The USD had lost most of the gains it had made in 2022, and US stocks had started the year in a bullish mood.

But the last few weeks have turned that outlook on its head. First, at the end of January, the non-farm payroll data showed that hiring nearly doubled in January, with the US economy adding more than a half million jobs — up from 223,000 in December. Then, on 14 February, the latest CPI data showed that, while inflation had cooled, it was not cooling as fast as expected. The markets responded warily, in a very much wait-and-see mode.

Then on 15 February, consumer spending data showed that retail sales rose 3 per cent over December’s levels. This was one of the biggest monthly increases of the past 20 years and far surpassed economists’ expectations for a 1.8 per cent increase.

Taken together, the data has flung open the door for further interest rate increases by the Fed. Jay Powell, Chair of the Federal Reserve, has repeatedly stated that the central bank will do anything it needs to do to pull inflation back to 2%. Market sentiment has reversed. US stocks wavered slightly before closing up, but the DXY, the index tracking the USD against a basket of other currencies, reached its highest level since 9^th January.

A lowering of interest rates in the mid-term now looks less and less likely, and all eyes will be on the next raft of data releases. PPI, housing starts, building permits and jobless claims will be pored over carefully and hawkish remarks by members of the Federal Reserve could trigger a sustained rally in the USD. In addition, after a strong start to 2023, technicals are now indicating a fall in US stocks as markets digest the data and consolidate gains.

But, as the FT is reporting today, some analysts are wary of the latest batch of data. James Knightley, chief international economist at ING, said January’s increase in sales was likely a result of the milder-than-usual weather. “We have to be a little cautious that with weather patterns returning to more seasonal norms in February, we could get a significant correction next month — especially with household finances remaining under pressure from high inflation and slowing wage growth.”