The U.S. dollar ended the week higher against all of the major currencies with today’s rally a delayed reaction to Thursday’s inflation report. Stronger than expected consumer confidence also helped to boost demand for U.S. dollars ahead of next week’s Federal Reserve monetary policy announcement. U.S. policymakers have insisted that the increase in inflation is transitory with disappointing consumer spending and labor market numbers discouraging taper talk next week.

However many central banks in weaker recovery positions have begun the process of policy normalization by reducing asset purchases so there’s growing belief that it is high time for the Federal Reserve to do so as well. It will be a close call next week because the Fed has consistently downplayed price pressures but the 5% year-over-year CPI increase is the largest in more than a decade. Excluding food and energy, the increase was the largest in nearly three decades. No other major country is running inflation as hot as the U.S. and the problem is that the high prices for travel, food, and autos may not fall as quickly as the Fed anticipates as some of these businesses look to recoup lost income.

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The rally in the U.S. dollar and rise in Treasury yields tells us that investors expect policymakers to discuss tapering and make subtle shifts in their language to prepare for that eventuality. With the market divided on which way the Fed will sway, Tuesday’s retail sales report will go a long way in setting expectations for Wednesday’s policy meeting.

Speculation about Fed taper talk and the European Central Bank’s decision to avoid the discussion sent EUR/USD tumbling on Friday. With no major Eurozone economic reports on next week’s calendar, the euro will take its cue from the market’s appetite for U.S. dollars. Sterling weakened despite mixed data. Monthly GDP growth and the trade balance were stronger than expected but industrial production unexpectedly declined. It is now widely believed that the U.K.’s target for a full reopening will be delayed from June 21st to the end of the month due to rising COVID cases. U.K. Chancellor Rishi Sunak said he could accept a delay of up to four weeks. As we mentioned in yesterday’s note, a delay would hurt sterling. Next week is a busy one for the U.K. with inflation, employment, and retail sales reports scheduled for release.

The New Zealand and Australian dollars were the worst performers with NZD falling on the back of disappointing manufacturing data. While the country’s PMI manufacturing index rose from 58.3 to 58.6, this increase barely offset last month’s sharp decline. New Zealand is further along in its recovery than the U.S. and the Reserve Bank of New Zealand is less dovish than the Fed, but as a high beta currency NZD is exceptionally vulnerable to risk appetite and demand for U.S. dollars. New Zealand's first-quarter GDP numbers are due for release next week. Data in Australia was less impressive, which explains the decline in AUD. Labor market numbers are due from Australia and after two months of subdued job growth, investors are hoping for a stronger recovery in jobs. USD/CAD rose to its strongest level in 3 weeks but a broader recovery hinges on Fed optimism.