Inflation Expectations Surge As the U.S. Dollar Tops Out

Three weeks ago I talked about a potential Fed calm before a market storm. Of course the S&P 500 (SPY) proceeded to drift higher from there and even notched one more all-time high just last Wednesday. However, the storm seemed to finally hit landfall in the form of poor consumer sentiment and inflation news which was pre-announced in preliminary form earlier in the month. Soaring consumer expectations for inflation provide yet one more confirmation that the Fed’s decision to hold steady on monetary policy is a wise move.

The chart below from the Surveys of Consumers – University of Michigan shows another interesting element of the inflation story. Long-term consumer expectations for inflation have remained elevated since the pandemic. The surge in short-term expectations may be strong enough to push longer-term expectations into breakout territory.

Source for Data: the Surveys of Consumers – University of Michigan

The latest spike in inflation expectations may soon cool off like the previous ones, but I do not expect the downtrend to resume from there given the current macroeconomic and policy environment. For example, as tariff talk translates into action which in turn translates into higher prices, I fully expect inflation expectations, at least short-term, to rise above current levels.

A Tired and Topping Dollar?

Interestingly, for all the talk about how tariffs will boost the U.S. dollar, the greenback is now down for the year and looks like it will continue trending downward. The Yale Budget Lab explains how the dollar strengthens from tariffs when there is no retaliation. When countries retaliate, their domestic demand for U.S. goods may decline and as a result demand for U.S. dollars declines. Could it be that the currency market is starting to wrestle with a net impact on the dollar from tariff wars just as consumers are starting to fear inflationary impacts from tariffs?

The U.S. dollar index (DXY) topped out in mid-January and is now down 1.7% for the year. (Source: Tradingview.com)

Canadian Resistance

Perhaps the volatile action against the Canadian dollar is instructive. When I last wrote, I explained why I decided to take profits on a long USD/CAD position. That exit turned out to be timely. Just two days later, USD/CAD surged right to resistance from the double-top formed across 2016 and 2020 highs and quickly reversed. President Trump created wild currency volatility by announcing tariffs on Saturday, February 1, and then reversing two days later with a 30-day “pause” following concessions from Canada. During this episode and in its wake, an active “Buy Canadian” movement has taken hold. If tariffs are re-enacted I expect vigorous retaliation from Canada. In other words, the dollar’s rally against the Canadian dollar may have indeed peaked on February 3rd with the blow-off top.

USD/CAD broke down below support at its 50-day moving average (DMA) (the red line above) and could be on track to eventually reverse all its gains from November’s big breakout. Source: TradingView.com

Having said that, I am not yet ready to short USD/CAD. I am actually long again preparing for the possibility of one more rally (to the 50DMA or maybe even challenge the high?) before USD/CAD confirms its top. My long USD/CAD is also a small hedge against other bets against the dollar.

Be careful out there!

Full disclosure: long USD/CAD, long SPY put spread