The dollar sliced through its rivals last week as inflation fired up, raising bets that the Fed will be forced to normalize at a faster clip. Markets are now split on whether the central bank will raise rates twice or three times next year, so the upcoming retail sales at 13:30 GMT Tuesday could be crucial. A solid report could tip the scales towards three hikes and give the dollar more fuel.
Inflation soars, dollar roars
With US inflation reaching its fastest pace in three decades, investors are betting that Fed officials will have to hit the normalization button sooner. The transitory narrative is slowly melting away, with even the Fed admitting this episode will probably last longer than expected.
Of course, price pressures are likely to cool next year as the supply disruptions start easing and more energy production comes online. The real question is, will inflation decline towards the Fed’s 2% goal, or will the American consumer and powerful government spending prevent that from happening?
An inflation rate of 3% would be a massive slowdown from current levels, but still far higher than the central bank is comfortable with. If that’s the case, the Fed may have to step on the brakes with force, raising interest rates faster. Markets are currently pricing in two rate hikes for next year and equal odds for a third one.
Early shopping?
There is a strong expectation in market circles that consumers will start their holiday shopping earlier this year, with supply disruptions and delivery delays everywhere. This could pull forward some demand from the November/December period towards October, artificially boosting the upcoming numbers.
Forecasts suggest US retail sales rose by 1.1% in October, faster than the 0.7% increase in September. Expectations are similar for the retail control group, which excludes several volatile items and is used in GDP calculations. Credit card spending data from JPMorgan Chase also point to a solid month for consumption.
Dollar reigns supreme
Overall, the outlook for the dollar remains quite bright. The American economy is just stronger than most of its competitors. Consumption is booming, lost jobs are coming back quickly, inflation is scorching hot, wage growth is firing up, and business surveys point to a strong spell of growth ahead. Best of all, Congress is bringing even more spending online. 
The other side of this coin is the euro, which is still grappling with several risks that threaten growth. Covid cases have skyrocketed again, resulting in the Netherlands imposing a partial lockdown last week. Austria and Germany could follow soon. Then there’s the spiral in energy prices squeezing consumers, and China’s slowdown spelling bad news for European exports.
Taken together, these imply that the European Central Bank could disappoint market expectations for a minor rate increase next year, while there is still scope for a third Fed rate hike to be priced in. Therefore, the risks surrounding euro/dollar seem tilted to the downside.
Taking a technical look at the pair, a strong retail sales report could see the bears pierce below the recent low of 1.1430 and potentially target the 1.1370 zone next.
On the flipside, a disappointment in the upcoming data might spark a relief rally. In this case, the 1.1525 region could provide initial resistance, ahead of the 50-day moving average currently at 1.1636 and the downtrend line.
Beyond macroeconomics factors, let’s not forget that the dollar also offers protection against drawdowns in stock markets, which may prove useful in this environment.
