Should currency traders act on inflation data?

Inflation and interest rates have been dominating financial news for months and causing currency traders to overthink their strategies. For some countries, inflation has been a runaway train since the lockdown years, but there are signs that some economies are taking back control, despite persistent whispers of an imminent global recession.

Aggregated global inflation is lower than last year, but the cost of living isn‘t reflecting that in many nations, which prompts the question: is inflation an accurate measure of economic strength and currency value？ Let’s look at the most popular currencies and speculate on whats coming in Q3.

CAD

Available pairs: USDCAD, AUDCAD, CADCHF, CADJPY, EURCAD, GBPCAD, NZDCAD

Canada's inflation rate dropped to 3.4% in May, a significant decrease from the 4.4% recorded in April 2023. This decline was primarily driven by a substantial 18% annual fall in gas prices, resulting in the lowest inflation rate in two years. Positive news on the surface. However, when excluding gasoline prices, the headline inflation remained at 4.4% in May. Lower fuel prices do not indicate a strengthening economy, so traders would be wise not to go “long” without another reason.

EURCAD may remain stable in the $1.43–$1.44 (CAD) range with limited growth over the long term. Occasional spikes of volatility with rapid corrections in Q3 may be common.

USD

Available pairs: AUDUSD, EURUSD, GBPUSD, NZDUSD, USDCAD, USDCHF, USDJPY, USDCNH, USDHKD, USDTHB, USDDKK, USDILS, USDMXN, USDNOK, USDPLN, USDSEK, USDSGD, USDZAR

The consumer price inflation in the United States fell to 4.0% in May 2023, the lowest since March 2021 and slightly below market expectations of 4.1%, driven by a decline in energy prices. Just how the U.S. is able to do this is unclear, given the recent increase of the debt ceiling, which mathematically requires more USD to be created, automatically devaluing the almighty dollar.

Analysts and independent media channels have been discussing further hikes on the horizon, but the Federal Reserve claims that inflation is transitory and will subside as the economy reopens. Theres nothing in the financial reports to support inflationary reduction or economic recovery, so it's possible the positive outlook for USD could be hype. Should this trend continue, watch for slow waves of price action within the $1.05 (USD) – $1.10 range, with brief reversals occurring every 3 to 4 weeks.

GBP

Available pairs: GBPUSD, EURGBP, GBPAUD, GBPCAD, GBPCHF, GBPJPY, GBPNZD, GBPDKK, GBPILS, GBPMXN, GBPNOK, GBPPLN, GBPSEK, GBPSGD, GBPZAR

The U.K. inflation rate remained high at 8.7% in May, despite government predictions that it would fall. There are a lot of forecasts circulating of core inflation levels falling to 2% by the end of the year, which would be in stages throughout Q3 and Q4, but theres very little action to back that positive outlook.

With no evidence of returning strength, be ready to see GBP playing around the $1.25 (USD) - $1.27 range, with a possible downward trend on the horizon.

EUR

Available pairs: EURUSD, EURAUD, EURCAD, EURCHF, EURGBP, EURJPY, EURNZD, EURDKK, EURMXN, EURNOK, EURPLN, EURSEK, EURSGD, EURZAR

The annual inflation rate for EU nations was 6.1% in May, down from 7% in April. The European Central Bank (ECB) has also been raising interest rates to try to bring eurozone inflation down. The rate is now 3.5%, the highest in 22 years, making the euro a more attractive proposition for outside investors.

With demand on the rise, EURUSD has enjoyed a steady climb from $1.06 to $1.09 since the beginning of June. Should this trend continue, expect long modest rallies followed by slow correcting declines between $1.05 and $1.10 throughout 2023.

JPY

Available pairs: USDJPY, AUDJPY, CADJPY, CHFJPY, EURJPY, GBPJPY, HKDJPY, NZDJPY, DKKJPY, MXNJPY, NOKJPY, PLNJPY, SEKJPY, SGDJPY, ZARJPY

The yen has finally recorded a fall in inflation after a harsh Q4-2022 that spilled into the new year, peaking at 4.30%. Now at 3.20%, economists are optimistic about Japanese inflation and consequently the yens value in 2023-Q3, which could support an overdue reversal of the bullish USDJPY.

With the ongoing and unexplainable USD rally that started with January‘s 127 (JPY) rising to today’s 143, a reversal might seem unlikely at the moment, but the heavy overbought signals on the Stochastic RSI do support a reversal. The rise of USD against JPY is still a mystery that defies economic mechanics, so dont discount the greenback just yet.

More volatility on all JPY pairs may occur as uncertainty continues to drive the markets.

Conclusion

Generally speaking, higher inflation tends to weaken a currency's value, forcing treasuries to raise interest rates, however, other factors such as economic growth, trade balance, political stability, and market sentiment can affect the market in ways that do not support inflationary price forecasts.

Currency traders relying solely on inflation data to make trading decisions will likely be disappointed in 2023. Before committing to any currency pairs, review GDP growth, unemployment rates, and consumer confidence. If all signals are bullish and central bank policies are not causing controversy, consider trading with modest leverage and tight take profit and stop loss.

Also notable, big investors and hedge fund managers tend to look to the future, not the present. Search for domino-effect signals such as commodity price shifts, wage growth, inflation expectation surveys, and even bond yields. All of these offer a precursor to economic activity.