USD softens ahead of release of latest US CPI report

USD: Will US CPI report support expectations for imminent rate cut?

The US dollar has weakened modestly overnight resulting in the dollar index falling back towards the 102.00-level ahead of the release today of the latest US CPI report for December. The correction lower for the US dollar has been encouraged in part by comments from New York Fed President Williams overnight which struck a less hawkish tone than those made on 15^th December when he attempted to more forcefully dampen rate cut speculation by stating that officials “aren’t really talking about rate cuts”. He appears to have softened his pushback against rate cut expectations by stating that “as inflation comes down over time” and the economy and labour market rebalances…”my expectation is interest rates will also come down over time”. However, he did not provide any strong indication over the potential timing of the Fed’s first rate cut stating only “the timing of when that happens and speed will depend on how inflation evolves”. The comments indicate he wants to become more confident that inflation is heading back to the Fed’s target on a sustained basis before lowering rates to less restrictive levels. While he now appears more open to lowering rates, it does not suggest that he is currently considering a rate cut as soon as in March.  

The comments will further increase the market’s focus on the release later today of the latest US CPI report for December to see if it provides further evidence of slowing inflation. Over the last six months to November, core CPI inflation slowed to an annualized rate of 2.9% down from 5.1% in the same period to the end of May. It has been firmer than the Fed’s preferred core PCE deflator measure of inflation that slowed to just 1.9% in November on an equivalent basis down from 4.5% in May. Unless there is a significant upside surprise in today’s CPI report today, the slowing inflation trend should encourage the Fed to begin cutting rates giving it more confidence that inflation is falling back towards their target.

Even though inflation has been slowing during the 2H of last year, US dollar performance immediately following the release of CPI reports has been mixed recently. The dollar index strengthened by +0.3% in the first hour after the last US CPI report was released on 12^th December, and has strengthened three times in the first hour following the release of the last six US CPI reports. The clearer trend is that the US dollar has moved more in percentage terms in response to the last three US CPI reports highlighting that inflation readings are becoming more important with Fed policy at a pivot point. With the US interest rate market still pricing in around 18bps of Fed cuts by March, another softer inflation reading will be required today to meet expectations for an early rate cut otherwise the dollar will attempt to stage a relief rally.

        

US CPI HAS BEEN RUNNING ABOVE FED’S PREFERRED MEASURE

Source: Bloomberg, Macrobond & MUFG

EUR: ECB officials encourage further paring back of rate cut expectations

The euro has been one of the best performing G10 currencies at the start of the new calendar year alongside the other major currencies of the pound and US dollar. In contrast, the yen has underperformed which has resulted in EUR/JPY rising by just over 3% back up to the 160.00-level. The yen sell-off was reinforced yesterday by the release of softer labour cash earnings data for November, although after adjusting for sample changes, base pay for regular workers has increased by 1.9% over the past year which should be positive news for the BoJ who are currently assessing whether stronger wage growth will be sustained in the coming fiscal year as well. Based on recent comments from Governor Ueda and near-term uncertainty related to the earthquake impact on the economy, it is unlikely now that the BoJ will have sufficient confidence to exit negative rates until April.   

While yields have been correcting lower in Japan at the start of this year, the opposite has been happening in the euro-zone. Market participants have been scaling back expectations over how quickly and deeply the ECB will likely cut rates this year. The implied yield on the March 2024 and December 2024 three-month interest rate futures contracts have increased by around 14bps and 33bps respectively since late last year. It still leaves the euro-zone rate market fully pricing in the first 25bps cut from the ECB by 11^th April policy meeting and a cumulative total of 136bps of cuts by year end. The recent hawkish repricing of ECB rate hike expectations was encouraged yesterday by comments from ECB officials indicating that they are in no rush to begin cutting rates imminently. Executive board member Schnabel stated that “it is too early to discuss rate cuts” which will require “additional data confirming the disinflationary process”. She views “wages, profits and productivity” as the key determinants the outlook for underlying inflation. It suggests that the first rate cut is unlikely until at least Q2 when the ECB has more data at hand.

Similarly, ECB Vice President De Guindos did not appear overly concerned over economic weakness in the euro-zone which he views as being “contained and gradual” so far with the labour market proving “particularly resilient”. He was encouraged by the “clear downward trajectory” for core inflation in late 2023 but expects inflation progress to pause at the start of this year. The ECB’s caution over delivering rate cuts as soon as the market expects is helping to encourage a stronger euro at the start of this year.

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
IT	09:00	Italian Industrial Production (MoM)	Nov	-0.2%	-0.2%	!
EC	09:00	ECB Economic Bulletin	--	--	--	!!
US	13:30	Core CPI (MoM)	Dec	0.3%	0.3%	!!!
US	13:30	CPI (MoM)	Dec	0.2%	0.1%	!!!
US	13:30	Initial Jobless Claims	--	210K	202K	!!!
US	17:40	FOMC Member Barkin Speaks	--	--	--	!

Source: Bloomberg