Goldman Sachs: No Boost From CPI With Fed Firmly On Hold

Goldman Sachs note that "U.S. CPI increased much more than expected in April, and supply constraints across the economy may put further upward pressure on consumer prices over the coming months. What does this mean for the Dollar? Holding all else equal, higher inflation in a given economy is negative for its currency… In practice, however, news of higher inflation may actually result in FX appreciation over the short run, if the central bank chooses to respond. If the central bank raises nominal interest rates more than one-for-one with inflation - such that real interest rates rise (i.e., the central bank follows the "Taylor principle") - then the currency could appreciate. Indeed, our own work on systematic trading rules in G10 suggests that accelerating inflation predicts mild FX gains in over relatively short windows. Whether higher-than-expected CPI inflation will result in Dollar appreciation or depreciation therefore comes down to the Fed's response. Our economists do not expect the FOMC to materially revise its outlook based on the recent inflation news, both because the committee will likely view the surge in prices as transitory and because this is the conventional way developed market central banks respond to the policy tradeoffs created by a supply shock. The worse-than-expected April employment report should reinforce the case for patience. With the Fed firmly on hold, we do not think higher inflation will support the Dollar, and we continue to forecast broad depreciation (with a preference for EUR/USD longs currently, given accelerating activity in the Euro area)."