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Investors could be forgiven for being baffled by unexpected market moves of late, most notably after the Dollar weakened despite rising US inflation.

What is baffling about the rally is why it has happened - the headline inflation reading of 2.1% was higher than the 1.9% expected, yet higher inflation would normally be expected to lead to a stronger, not a weaker Dollar?

The reason the Dollar rises on stronger inflation is that central banks tend to put up interest rates when inflation rises and higher interest rates strengthen the Dollar by attracting greater inflows of foreign capital drawn by the promise of higher returns.

Yet this time the relationship broke down and the opposite happened: the Dollar weakened instead, and this has got market analysts scratching their heads wondering why.

One cogent explanation for the Dollar's unexpected behaviour has come from Société Générale macro strategist Kit Juckes, who puts the Dollar's weakness down to the strong performance of the 'rest of the world' or RoW as it is known, reflected in the fact global stock markets rallied.

RoW argues Juckes, has now taken over as the primary driver of the Dollar and not simply interest rates.

"The better the global economic story, the worse it is for the dollar. The biggest single factor undermining the dollar this year has been the improvement in the global economy - a more balanced economic recovery drags investment away from the US and towards more interesting markets," says Juckes.

Apparently, the Dollar's correlation with higher inflation and interest rates is a relatively recent phenomenon probably caused more by a rare combination of the extraordinarily low inflation and interest rates after the great financial crisis combined with global capital flows.

Prior to 2013, this was not the case.

"Jason Daw argues here that it was normal prior to 2013 for emerging market currencies to do well alongside rising US yields and the same arguments can be used when we want to understand why higher yields aren't helping the dollar overall," says Juckes.

That global stock markets rose despite the rise in inflation may not be the only reason the Dollar weakened rather than rose following yesterday's data.

Another reason could be that although inflation may be rising, markets don't think this will translate into higher interest rates.

In the UK, for example, inflation is at 3.0% and yet the Bank of England (BOE) is not putting up rates as rapidly as the US Federal Reserve because they are afraid economic growth is not strong enough to withstand higher interest rates.

In short, the high inflation is imported due to a weak Pound and unaccompanied by growth, so interest rates have to kept down to safeguard debtors.

The US may be suffering a similar problem ie inflation without growth, or 'stagflation' as it is known and this may make the Fed reluctant to raise interest rates despite Wednesday's higher inflation print.

"The USD continues to suffer. The word that has been whispered in some corners but really came up yesterday is stagflation. Rising inflation against softer growth is a concern for the Fed and might make it step back from hiking too quickly," says ETX Capital market analyst Niel Wilson,

Since it is really higher interest rates which are the driver for currencies and not higher inflation per se if the inflation fails to cause a concrete hike it's not going to impact on the currency.

Wilson's argument, if accurate, would also explain why global stock markets rallied despite the rising inflation print.

Normally this would not be the case because of the large amount of US originated and denominated debt held by companies in emerging markets.

When US interest rates rise and the Dollar strengthens debt repayments for these companies get more expensive and EM financial markets tend to fall.

Yet if, as Wilson argues, 'stagflation' may be present, then interest rates are not as likely to rise and EM debtors won't suffer.

Despite suggesting this may be the reason the analyst is still cautious, arguing growth in the US is still actually relatively robust.

"It’s too early to call stagflation and it’s worth noting that growth remains robust, although we must note that GDP expectations have been revised sharply lower since the report."

The US Dollar could also have been unresponsive to the inflation result due to other factors.

It is often more in the early stages of tightening cycles when central banks are just starting to hike rates that currencies are most responsive to rising interest rates, and we have arguably now passed that stage - some even argue the US may be in the later stages of its cycle.

Another area concern is the widening 'twin deficit' due to the government's widening budget deficit, which is set to get wider from tax cuts and increased spending, and the widening current account deficit, which is increasing due to a fall in portfolio flows now the US stock and bond markets are less attractive to foreign investors.

"USD remains shrouded by the fiscal outlook and concerns that we may be reaching the end of the cycle. Higher inflation, a slackening in growth and the US government running a higher deficit looks like a nasty cocktail of weakness for the dollar," says Wilson, who adds:

"Ironically, if the data makes the Fed take its foot off the pedal by refocusing its attention on more than just inflation, we could see the dollar bounce back."

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