Dollar plummets as US inflation cools

Important calendar events

• JPY: Preliminary GDP Price Index, Preliminary GDP, Revised Industrial Production
• GBP: CPI and Core CPI, PPI Input and Output, RPI, HPI, Monetary Policy Report Hearings
• EUR: Industrial Production, Trade Balance
• USD: PPI and Core PPI, Empire State Manufacturing Index, Retail Sales, Core Retail Sales

USD

The dollar plummeted on Tuesday as US inflation surprised on the downside, and the dollar index plunged to the 104.0 level. US treasury yields also dipped, with the US 10-year bond yielding approximately 4.44%. 

Inflation in the US eased more than expected, driving down rate hike expectations and putting pressure on the dollar. Headline inflation rose by 3.2% year-on-year in October from a 3.7% reading in September and against expectations of a 3.3% print. Monthly CPI remained unchanged from the previous month in October, while markets were anticipating a 0.1% raise. Core CPI, which excludes food and energy, also surprised on the downside. Core CPI increased by 0.2% monthly, compared to 0.3% anticipated.

US PPI data are scheduled to be released on Wednesday and may provide a more complete picture of the direction of US inflation after Tuesday’s CPI data. The Fed’s hawkish stance over the past year has been paying off and US price pressures are cooling. 

At the latest Fed meeting in November, FOMC members voted to keep interest rates unchanged at a 22-year high within a target range of 5.25% to 5.50%. The Fed has made it clear that its approach from now on will be data-driven and Tuesday’s inflation data have brought the odds of a rate hike in December to zero. Markets are pricing at an end to rate hikes and are even starting to price in rate cuts. Markets are always ahead of events and are already pricing at an end to the Fed’s tightening policy. 

Market expectations of rate cuts have been driving the US dollar and treasury yields down. The Fed, however, has been relying on high treasury yields to complement its tightening policy. Plummeting treasury yields may derail the Fed's plans to end rate hikes or force the Fed to keep interest rates at high levels for longer.

The Fed has likely become alarmed by the recent plunge in treasury yields. Fed Chair Jerome Powell delivered a hawkish speech last week, boosting the dollar and treasury yields. Powell warned that policymakers are not confident that they have achieved a sufficiently restrictive stance to return inflation to the Fed’s 2.0% target. Powell also stressed that a sustainable drop in inflation is not guaranteed and hinted that stronger economic growth could warrant higher rates.

The US economy is recovering, boosting the dollar. Advance GDP data for the third quarter of 2023 showed that the US economy expanded by 4.9%, against expectations of 4.5% growth and far surpassing the 2.1% growth of Q2. Advance GDP price index for the 3rd quarter of the year reached 3.5%, exceeding expectations of a 2.7% print. 

Core PCE Price Index, which is the Fed’s preferred inflation gauge, rose by 0.3% in September, in line with expectations. Core PCE Price Index dropped to 3.7% year-on-year in September from a 3.8% print the previous month. Inflationary pressures in the US are easing, reinforcing the notion that the Federal Reserve will not have to raise interest rates further. US headline inflation in September, however, remained at August's levels of 3.7% year-on-year, while market analysts were expecting a drop to 3.6%. 

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EUR 

EUR/USD surged on Tuesday after the release of the US CPI report and the currency rate was catapulted to 1.088. If the EUR/USD pair declines, it may find support at 1.065, while resistance may be encountered near 1.094. 

The ECB decided to keep interest rates unchanged at 4.50% in October. Markets anticipate that the ECB has hit its rate ceiling, putting pressure on the Euro. The ECB is tasked with assessing the risk to the fragile Eurozone economy against high inflation rates. 

ECB President Christine Lagarde has hinted at an end to rate hikes. Lagarde highlighted the risks to the Eurozone economy stressing that the economy is likely to remain weak for the remainder of the year. Lagarde also stated that it is too early to talk about rate cuts and warned that interest rates will remain at sufficiently restrictive levels for as long as necessary.

The economic outlook of the Eurozone appears to be deteriorating, putting pressure on the Euro. Preliminary GDP data for the Euro area showed that the Eurozone economy contracted by 0.1% in the third quarter of the year against expectations of stagnation. The Eurozone economy barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1 of 2023. The EU economy is struggling and cannot withstand much further tightening. 

Headline inflation in the Eurozone fell to its lowest level in two years in October, mainly due to a drop in energy prices. Flash CPI cooled to 2.9% year-on-year in October from 4.3% in September against expectations of a 3.1% print. Core CPI Flash Estimate, which excludes food and energy, was in line with expectations. Core CPI eased to 4.2% year-on-year in October from 4.5% in September. The ECB’s efforts to curb inflation rates are paying off, even at the cost of decreased economic growth.

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GBP 

GBP/USD skyrocketed on Tuesday, rising to the 1.250 level as the dollar plummeted. If the GBP/USD rate goes up, it may encounter resistance near 1.255, while support may be found near 1.218. 

On the data front, Claimant Count Change, which represents the change in the price businesses pay for labor, increased by 17.8K in the three months to September compared to the same period a year earlier. This is a leading indicator of consumer inflation, and the sharp rise shows increasing inflationary pressures. Average Earnings Index data released on Tuesday showed UK workers’ wages grew by 7.9% in the three months to September, which was slightly lower than the previous record pace of 8.2%, but surpassed expectations of 7.4%. Rightmove HPI data released on Monday showed that UK housing prices have fallen at their quickest pace in five years in November, pushed down by economic tightening. 

Odds that the BOE has reached its rate ceiling are putting pressure on the Sterling. Markets are pricing in more than a 50% chance of rates being unchanged until June 2024. On the other hand, interest rates are expected to remain at their current 15-year high for a long time, with markets predicting a rate cut in August next year.

The BOE maintained its official rate at 5.25% at its latest meeting, which was in line with expectations. The BOE has likely reached its rate ceiling but will keep interest rates on hold for a long time to bring inflation down. 

BOE Governor Andrew Bailey has stated that the central bank will be watching closely to see if further rate hikes are needed. Bailey has also emphasized that the BOE will be holding interest rates in restrictive territory long enough to see inflation down to the bank’s 2% target.

Recent fundamentals have shown that the British economy remains fragile, reinforcing the notion that the BOE has reached its peak interest rates. Prolonged tightening has taken its toll on the labor market and other vital economic sectors.

UK GDP data revealed that the British economy remained stagnant during the third quarter of 2023. The British economy expanded by 0.3% in the first quarter of the year and 0.2% in the second quarter. Economic growth is slowing down in the UK and the country is on the brink of recession.

British Inflation is not cooling down fast enough, despite the BOE’s consistently hawkish policy. Headline inflation remained at 6.7% year-on-year in September, the same as in August, against expectations of a drop to 6.6%. 

A combination of a struggling economy and high inflation is making the BOE’s task more difficult. Further tightening is needed to bring inflation down at the risk of tipping the British economy into recession. 

Important inflation data are scheduled to be released on Wednesday for the UK and are expected to affect the price of the Sterling.

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JPY

The Yen found some relief on Tuesday after USD/JPY reached 30-year highs on Monday. The currency rate retreated on Tuesday as the dollar plunged but remained stubbornly above the key 150 level. If the USD/JPY pair declines, it may find support near 148.8. If the pair climbs, it may find resistance at 152.

The BOJ has so far maintained its dovish bias, putting more pressure on the Yen as other major central banks, and especially the Fed, have raised interest rates to high levels. Japanese authorities have been repeatedly warning speculators against excessive short selling of the Yen and have stepped in several times in the past year to provide support for the Yen. 

The BOJ maintained its short-term interest rate target steady at -0.10% and that for the 10-year government bond yield around 0% set under its yield curve control, but redefined the 1.0% limit as a less restrictive ceiling rather than a rigid cap. Even though the BOJ tweaked its yield curve control policy slightly, markets were expecting a bigger shift in policy, and the Yen plummeted after the interest rate announcement. 

National Core CPI dropped to 2.8% in September from 3.3% in August. Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. 

Final GDP data for the second quarter of the year showed that the Japanese economy expanded by 1.2%, disappointing expectations of 1.4% growth. The final GDP Price Index showed a 3.5% annual expansion, versus 3.4% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.

Preliminary GDP and GDP Price Index data are scheduled to be released on Wednesday for Japan and will provide information on the country’s economic outlook.

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Written by:
Myrsini Giannouli

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