Daily Market Comment – Investors lock gaze on US inflation numbers

  • Dollar trades mixed ahead of US CPI data
  • Inflation expected to further slow
  • Euro, yen could continue outperforming the dollar
  • Wall Street trades in the green on inflation optimism

Will US CPI numbers corroborate the Fed pivot view?

The US dollar traded mixed against the other major currencies yesterday and continued in a similar fashion today.

Apart from some moves triggered by stories related to other currencies, dollar traders seem to be avoiding heavy positioning ahead of today’s US CPI data. The forecasts are for both the headline and core rates to have continued to decline, something that could support investors’ view of a Fed pivot at some point this year.

Despite Fed officials adamantly favoring raising rates to above 5% and staying on hold thereafter, market participants remain unconvinced that the Fed could outpace their expectations. They are currently seeing rates peaking at 4.95% in June, and more importantly, they are stubbornly maintaining bets of around 50bps worth of rate reductions by the end of the year.

Such expectations are likely to keep the US dollar in a downtrend for a while longer, but how the currency may react at the time of the release is likely to depend on how the actual numbers compare to the forecasts. Given that investors seem to have sold a few more dollars the last few days, an in-line print or a smaller-than-expected slowdown could trigger a “buy the fact” response. However, this is very unlikely to prove a game changer. It could be seen as a short-term correction providing renewed dollar selling opportunities. On the other hand, a bigger-than-expected slowdown could result in an immediate selling of the greenback.

Euro and yen could perform well for a while longer

The dollar has been underperforming most of the other major currencies the last few months, but there are a couple that could perform better than others. One of them may be the euro. In contrast to the US, underlying inflation in the Euro area is still accelerating, which validates the view that the ECB may continue tightening more aggressively than the Fed henceforth. The good weather is also giving a helping hand to the common currency as it eases concerns with regards to the performance of the European economy. Euro/dollar is slowly getting closer to the important barrier of 1.0800, the break of which could carry larger bullish implications.

Another currency that could perform well against the greenback in coming months may be the yen. Following the BoJ’s decision to widen the band it sets around its 10-year bond yield target, as well as speculation that it will likely raise its core inflation forecasts, a newspaper reported today that officials will review the side-effects of monetary easing at next week’s gathering and may proceed with additional action to correct distortions in the yield curve.

The yen strengthened today following the headlines and may continue to benefit from speculation that the BoJ could continue removing monetary accommodation. Concerns about the performance of the global economy could also prove beneficial through safe-haven inflows.

As for the commodity-linked currencies, they have been gaining ground recently, due to news about China’s reopening, but should upcoming headlines and developments reignite fears of economic complications due to soaring COVID infections and a potential spreading of new variants, those currencies may easily come under pressure.

Stock investors buy the rumor, will they sell the fact?

Wall Street ended Wednesday sharply up, adding to the hypothesis that a slowdown in today’s inflation data may already be expected. So, if the actual prints match or come in above their forecasts, stocks could slide. They may extend their gains if the data surprises to the downside.

Having said that though, even with equities gaining a bit more on expectations of lower interest rates, the outlook will most likely remain gloomy. Releases relating more to economic growth have been worsening, with the latest example being the ISM non-manufacturing PMI for December, which fell into contractionary territory for the first time since May 2020. Therefore, increasing fears about the performance of the US economy could force equities to resume their downtrend at some point soon. In the aftermath of the CPI data, the S&P 500 could be stopped by the strong downtrend line drawn from the high of January 4 last year, but even if it climbs higher, the bulls may be obliged to abandon the battle near the key resistance zone of 4155.


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