Risk Sentiment Improves As Inflation Fears Ease

By:
Lukman Otunuga
Published: May 25, 2021, 09:45 UTC

Asian markets flashed green on Tuesday while US futures rose after technology shares led gains on Wall Street overnight.

Risk Sentiment Improves As Inflation Fears Ease

As a chorus of Fed officials reiterated that the recent pickup in inflation would be transitory, investor fears were soothed about rising prices forcing higher interest rates. US equity bulls rejoiced on this development, encouraging buying in expensive growth stocks in sectors such as technology.

While these comments have lifted risk sentiment and offered support to stock markets, concerns still linger over the Fed taking action sooner, rather than later if inflationary pressures mount. In the meantime, financial markets are likely to remain highly sensitive to inflation expectations and comments from Fed officials on this topic.

Dollar drifts lower…

The past few weeks have certainly not been kind to the dollar.

It has weakened against every single G10 currency this month and remains vulnerable to further losses amid weaker treasury yields. Although inflation worries are receding following the latest comments from Fed officials, the damage has already been inflicted on the dollar.

The main risk events for the greenback today will be the US new home sales and consumer confidence data. For April, sales of new homes are expected to hit 950,000, falling from the 1,021,000 new homes sales in March. In regard to consumer confidence, it is expected to decline slightly in May falling to 119 from 121.7 in April.

Focusing on the technical picture, the Dollar Index is under pressure on the daily charts. Sustained weakness below the psychological 90.00 level may encourage a decline towards 89.30.

Germany GDP downgraded in Q1

The euro offered a muted response this morning to the news that Germany’s economy contracted in the first quarter by more than reported in the first release. Europe’s largest economy shrank by 1.8% quarter-on-quarter in the three months to March 2021 which was weaker than the first estimate of -1.7%. On the year, the economy shrank 3.1% compared to the 3.0% preliminary estimate. Despite the downgrade, the economic outlook is starting to brighten as coronavirus cases fall and lockdown restrictions ease across the continent.

The EUR/USD is currently trading above 1.2250 and dollar weakness could send the pair towards levels not seen since early January at 1.2300.

Commodity spotlight – Gold

Gold continues to shine thanks to a weaker dollar, falling Treasury yields and extreme volatility in the cryptocurrency space.

The precious metal is trading around levels not seen in four months and is up over six per cent in May. Despite the receding US inflation fears, gold is supported by other fundamental drivers. Although the path of least resistance points north, the price action around $1870 could determine whether gold extends gains or experiences a technical pullback this week. Should $1870 prove to be reliable support, a move towards $1900 could be on the cards. However, a decline below $1870 may signal a drop towards $1855 and $1840, respectively.

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About the Author

Lukman Otunuga is a research analyst at FXTM. A keen follower of macroeconomic events, with a strong professional and academic background in finance, Lukman is well versed in the various factors affecting the currency and commodity markets.

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