After a recent dip, the dollar continues to show signs of recovery as inflation data revealed unexpected ease in core prices for December. This development has provided some reassurance to traders, particularly in light of Treasury yields experiencing a decline, with the 10-year yield retreating below the 4.7% threshold.
The State of US Inflation
Data indicates a rise in the Core Consumer Price Index (CPI) by 3.2% year-on-year, which is a slight decrease from the previous month’s 3.3%. This marginally lower figure alleviated concerns regarding escalating inflation that might compel the Federal Reserve (Fed) to reconsider its current approach to monetary policy, which has included a gradual loosening in bias. Nevertheless, while core inflation levels remain high, the latest data suggests that immediate pressures are not intensifying significantly enough to warrant any abrupt shifts in Fed policy.
Market expectations have reflected this sentiment, with futures indicating a staggering 97.3% likelihood that the Fed will maintain its current rate at the upcoming January FOMC meeting. Additionally, anticipated rate cuts are gaining traction, with expectations for a reduction rising to 49% for May, an increase from 36% just a day earlier. In fact, by June, markets predict a nearly 70% chance of a rate cut occurring, aligning with broader projections that anticipate only a single reduction in rates through the entirety of 2025.
Currency Performance in the Forex Market
Within the foreign exchange market, the dollar showed weakness and became a low performer for the day. In contrast, currencies like the Canadian Dollar and Swiss Franc also struggled. However, the Japanese Yen made notable gains, buoyed by statements from Bank of Japan (BoJ) officials which revived speculation about a potential rate hike during the January meeting. Notably, both the Australian Dollar and New Zealand Dollar performed well, reflecting stronger risk sentiment. Conversely, the Euro and British Sterling displayed mixed trading momentum, remaining in a relatively neutral position.
From a technical analysis standpoint, despite the dollar’s ongoing pullback, it has managed to stay above crucial support levels against key counterparts. For instance, the EUR/USD pair is currently constrained beneath a resistance level at 1.0435, while GBP/USD remains capped below 1.2486. Similarly, AUD/USD is finding resistance at 0.6301, and USD/CHF holds support above 0.9007. As long as these significant levels can withstand pressure, the general bullish trend for the dollar stays intact, suggesting that the current market behavior aligns more with a consolidation phase rather than a definitive reversal.
Detailed Analysis of US CPI
Revisiting the CPI statistics for December, a month-on-month increase of 0.4% was recorded, surpassing the market expectation of 0.3% and representing an uptick from the previous month’s increase of 0.3%. When analyzed separately, the core CPI—exempting volatile food and energy prices—rose by 0.2%, matching market predictions but marking a decrease compared to November’s 0.3% rise.
Energy prices emerged as a dominating force, advancing by 2.6% month on month and contributing over 40% to the overall inflation increase. Food prices were not left behind, witnessing a 0.3% uptick, further intensifying inflationary pressures. Over the long term, headline inflation surged to 2.9% year-on-year, in line with predicted figures and an ascent from November’s 2.7%. Meanwhile, core inflation softened to 3.2% year-on-year, slipping below the forecasted 3.3% and signaling an easing of underlying price pressures. Importantly, energy prices actually declined by 0.5% year-on-year, while food prices remained stubbornly high at a 2.5% increase year-on-year.
Eurozone’s Industrial Performance
Shifting focus to Europe, eurozone industrial production displayed a modest rise of 0.2% month-on-month in November, falling short of the anticipated 0.3% growth as per market consensus. Despite the overall improvement, sector performance varied significantly. Durable consumer goods production increased by 1.5%, alongside a 1.1% boost for the energy sector, suggesting robust demand in these categories. Conversely, non-durable consumer goods saw only a slight improvement of 0.1%.
When considering the wider European Union, the industrial sector only marginally grew by 0.1% over the same period. Significant monthly increases were noted in Belgium (+8.7%), Malta (+7.1%), and Lithuania (+4.3%). In stark contrast, declines were most evident in Ireland (-5.8%), Luxembourg (-3.9%), and Portugal (-3.4%).
Progress on Disinflation in the Eurozone
Amidst these economic dynamics, the Vice President of the European Central Bank (ECB), Luis de Guindos, underscored that disinflationary trends in the eurozone continue to progress positively. Despite seeing December’s inflation rise to 2.4%, Guindos indicated that this rise was anticipated and remained consistent with the ECB’s objectives. He acknowledged that while inflation levels remain elevated, easing trends in recent months offer a glimmer of hope.
But caution remains paramount, as Guindos pointed to persistent global uncertainties—including ongoing trade tensions and fiscal policy challenges—that could aggravate the economic landscape. He expressed expectations for a strengthening economic environment, albeit at a rate beneath previously projected figures.
French ECB member François Villeroy de Galhau echoed the positive sentiment, stating that the battle against inflation is nearly won and projected interest rates could reach 2% by summer. Nonetheless, he recognized potential risks to France’s 2025 growth forecast, asserting that while a recession appears unlikely, some uncertainties linger.
Insights on Future Inflation and Exchange Rates
Philip Lane, the Chief Economist of the ECB, provided insights into future expectations regarding service-oriented inflation, predicting a significant downtrend in the upcoming months. He attributed this anticipated moderation primarily to a slowdown in wage growth, alongside a reduction in cost pressures faced by businesses, both of which are expected to mitigate price increases.
Furthermore, Lane acknowledged the complexities surrounding interest rate forecasting, emphasizing the heightened global uncertainties—including trade conflicts—that complicate future monetary policy decisions. When it comes to exchange rates, he remarked that while fluctuations in the euro-dollar exchange can inevitably affect European prices over time, the immediate correlation remains unpredictable. He noted that initial significant currency shifts are often absorbed by firms, indicating a delay before any price adjustments manifest.
UK Inflation Trends
Moving across the channel, the UK’s Consumer Price Index (CPI) decreased to 2.5% year-on-year in December from the prior figure of 2.6%, falling short of expectations of 2.7%. Similarly, core CPI decreased from 3.5% to 3.2%, also below the predicted 3.4%. On a monthly basis, CPI rose 0.3%, slightly lower than the forecasted 0.4%.
Monetary Policy Signals from BoJ
In Asia, Bank of Japan (BoJ) Governor Kazuo Ueda hinted at a possible interest rate hike in the forthcoming policy meeting. Ueda stated that the central bank is thoroughly analyzing data and will consider interest rate adjustments during the upcoming meeting. He reflected upon positive developments in wage negotiations, which could stimulate consumer spending and align with BoJ’s inflation objectives.
The statements from Ueda are in coordination with sentiments expressed by BoJ Deputy Governor Ryozo Himino, indicating that a shift in monetary policy could be on the horizon.
EUR/USD Mid-Day Assessment
Looking at the EUR/USD exchange rate, the pair has made a recovery from a recent low of 1.0176. The current upward movement remains tethered beneath the resistance point of 1.0435. Intraday bias is regarded as neutral while anticipating further declines. A breakthrough below 1.0176 would sustain the downward trend from 1.1213, targeting a significant projection down to 1.0083. However, bullish convergence noted in the 4-hour MACD indicates a potential upswing if the pair breaks above 1.0435, which could lead to a stronger rebound.
From a broader perspective, the decline from the 1.1274 high in 2023 could either indicate the second leg in a corrective pattern from the recent low of 0.9534 or serve as another decline in the long-term downtrend. The outlook remains bearish unless the 1.0629 resistance level is surmounted, even amid robust rebound attempts.
Economic Indicators Breakdown
As an overview, key economic indicators recently shared across global markets include:
- JPY Money Supply M2+CD Year-on-Year: 1.30% actual vs. 1.20% forecast
- GBP CPI Monthly Change: 0.30% actual vs. 0.40% forecast
- GBP Core CPI: 3.20% actual vs. 3.40% forecast
- Eurozone Industrial Production Monthly Change: 0.20% actual vs. 0.30% forecast
- US CPI Monthly Change: 0.40% actual vs. 0.30% forecast
Conclusion
In summary, recent developments in inflation data indicate a period of stabilization, as core CPI in the US shows slight easing, subsequently providing relief to the dollar and influencing Fed policy expectations. In the forex markets, the dollar’s weakness contrasts with gains from the yen and other currencies, while the eurozone faces mixed economic signals. With the ECB expressing cautious optimism regarding disinflation and the BoJ hinting at potential rate adjustments, a complex and evolving economic landscape lies ahead for traders and policymakers alike.
Frequently Asked Questions
Q1: How do inflation rates influence currency values?
A1: Inflation rates significantly affect currency values as higher inflation can erode purchasing power, leading to lower demand for a currency. Conversely, lower inflation rates typically strengthen a currency, indicating stability and potentially leading to higher interest rates.
Q2: What role do central banks play in controlling inflation?
A2: Central banks regulate monetary policy to influence inflation rates. They can adjust interest rates, control money supply, and implement other monetary tools to stabilize the economy and manage inflation expectations.
Q3: What is the significance of core CPI versus headline CPI?
A3: Core CPI excludes volatile elements like food and energy prices, providing a clearer picture of underlying inflation trends without short-term fluctuations. Headline CPI includes all categories, making it more reflective of immediate economic conditions.
Q4: Why is the performance of industrial production important?
A4: Industrial production reflects the health of an economy, as it indicates manufacturing and production levels. An increase can signal economic expansion and consumer demand, impacting GDP growth rates and influencing market sentiment.
Q5: How do geopolitical tensions affect the global economy?
A5: Geopolitical tensions can disrupt trade, lead to higher energy costs, and create uncertainty in global markets. This instability can inhibit investment and consumer spending, leading to slower economic growth and potentially higher inflation.
References
- Federal Reserve Economic Data
- European Central Bank Communications
- Bloomberg Market Updates
- Various Financial News Reports
- Bloomberg Economic Insights