US Inflation Sets Course for Dollar and Fed Interest Rates

The dollar is trading almost stable this Monday, quoted at R$ 5.087, after a Friday that shook market expectations. The July payroll surprised negatively, showing that the American economy lost jobs for the first time in months. The numbers for the previous two months were also significantly revised downwards.

The immediate reaction was a reduction in bets on interest rate hikes by the Federal Reserve at the next meeting. However, the market knows that a single data point does not change the direction of monetary policy. That is why all attention is now focused on the Consumer Price Index (CPI) in the United States, which will be released on Wednesday.

The weak employment report created a narrative: the American economy may be slowing down faster than the Fed had anticipated. If the July CPI confirms this trend, with falling inflation, the scenario changes substantially. Economists surveyed by Reuters project a 3.4% annual increase, down from 3.5% the previous month.

A slowdown of 0.1 percentage points may seem irrelevant on paper. But in the current context, it represents the second consecutive month of decline, which would reinforce the thesis that monetary tightening is working. As we explained in our coverage of monetary policy, the Fed has conditioned its decisions on concrete data, and the combination of weak employment with falling inflation would make it difficult to justify another interest rate hike.

On the other hand, if the CPI comes in above expectations, the market will have to recalibrate quickly. Higher interest rates for a longer period in the US mean a stronger dollar globally, which pressures emerging currencies like the real.

The stability of the dollar this Monday is, in itself, a relevant data point. After the weak payroll, it would be reasonable to expect a more significant drop in the American currency. This did not happen. The future dollar for September is trading at R$ 5.114, practically at the same level as the previous session.

The reading is that the market is in a wait-and-see mode. No one wants to take significant positions before the CPI. It is the classic behavior of "sitting on hands" that precedes high-relevance macroeconomic data.

For Brazilian investors, this dynamic is particularly important. The level of the dollar directly affects the cost of imports, domestic inflation, and consequently, the Central Bank's decisions regarding the Selic rate. As we discussed in previous analyses about the interest rate scenario, the monetary cycles of Brazil and the US are more interconnected than ever.

In addition to economic data, the geopolitical scenario remains on the radar. Iran stated that negotiations with Oman regarding transit through the Strait of Hormuz are in the final phase, but conditioned the reopening of the waterway on the fulfillment of requirements by the United States.

The Strait of Hormuz is one of the world's most important maritime corridors for oil transportation. Any instability in the region tends to push commodity prices up, which has cascading effects on global inflation and, by extension, on central bank decisions.

For Brazil, which is a net exporter of oil, the effect is ambiguous. Higher prices benefit the trade balance and companies like Petrobras, but they increase domestic prices of derivatives and complicate the Central Bank's work in controlling inflation.

Wednesday will be the most important day of the week for global markets. The American CPI, combined with the already released employment data, will shape the narrative about interest rates until the next Fed meeting.

There are basically three possible scenarios:

• CPI below 3.4%: strengthens the thesis of a pause in interest rates. Dollar tends to decline, risk assets rise, real appreciates.
• CPI in line with expectations (3.4%): maintains the current uncertainty scenario. Dollar remains in the range of R$ 5.05 to R$ 5.15.
• CPI above 3.4%: revives the bet on another interest rate hike. Dollar strengthens, emerging markets face pressure.

For those exposed to American assets, whether via BDRs, ETFs, or direct investment, the CPI can alter the risk-return relationship of these positions in the short term. For those positioned in Brazilian fixed income, the question is whether the interest rate differential between Brazil and the US will widen or shrink.

The employment data has already given a hint. Inflation will confirm or contradict. And it is in this confirmation that lies the difference between a dollar at R$ 4.90 and a dollar at R$ 5.30 in the coming weeks.

The only certainty, for now, is that the market will not make big decisions until Wednesday. And for investors, patience is, at this moment, the most rational position.