Economists will tell you that ceteris paribus – all else being equal – higher inflation leads to a lower exchange rate, writes the FT’s John Authers in Thursday’s Short View column. If a currency’s buying power is reduced, it should weaken compared with other currencies.But all other things are not equal at present. So when Wednesday’s price inflation data in the US showed prices rising faster than expected, the dollar gained strongly.
This is partly because persistent inflationary pressures make it harder for the Federal Reserve to cut interest rates, and higher rates (ceteris paribus) keep the currency higher. But Fed Funds futures suggest the market is confident that the Fed must keep cutting, including at its meeting next month.
And in any case stocks rallied on Wednesday – not what would be predicted if rate cuts go off the agenda.
More intriguingly, rising inflation implies that economic activity is not slacking. In recent weeks, the US market has plainly been more scared about the “Japanese” outcome – in which economic activity collapses, bringing inflation down with it.
This can be seen in the still low inflation expectations implied by Treasury inflation-protected securities (Tips).
Evidence that the US can avoid such a nightmare scenario is good news for the dollar and for stocks.
There is every reason to expect the “headline” rate, now at 4.3 per cent, will continue to grow faster than the “core” rate, which excludes energy and food: oil is now about $100 per barrel, and agricultural commodities are in a bull market (up almost 15 per cent this year).
That shows that inflation is alive and well in the world, and that demand in the emerging world is very resilient.
Ceteris paribus, that would justify the market’s resurgent faith in emerging market stocks, which have rallied more than 10 per cent in less than a month.
