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Will U.S. CPI Weaken Fed's Resolve To Slow Rate Hikes?


Ever since the Fed Chair Jerome Powell announced on November 30 a commitment to moderate interest rate increases, markets have been jolted by a series of data releases that threatened to jeopardize the Fed’s intentions.

The higher-than-expected readings of non-farm payrolls added, services PMI, and producer price inflation have raised doubts on whether the Fed would be able to slow its pace of rate hikes as intended. Will the U.S. CPI data due on Tuesday be the next to weaken the Fed’s resolve?

According to the latest consensus estimates, CPI for the month of November is seen falling to 7.3 percent, from 7.7 percent in the previous month. Core inflation – the Fed’s preferred inflation gauge that excludes the volatile food and fuel prices – is seen falling to 6.1 percent from 6.3 percent in the previous month. Except for any negative surprises, the CPI data should help the Fed slow down on rate hikes.

However, several recent data releases that implied a strong economy and resilient labor market have cautioned markets against premature euphoria. The U.S. CPI data release due on Tuesday and the Fed’s interest rate review due on Wednesday therefore continue to hold sway over market sentiment worldwide.
While markets apparently are anticipating the Fed to raise rates by 50 basis points, the tone of the accompanying commentary as well as the updates to the economic projections related to GDP, unemployment, inflation and the federal funds rate would provide detailed forward guidance on the Fed’s monetary policy strategy.
The impending inflation data release and the Fed’s upcoming review provided the contextual backdrop for currency markets in the past week.
The ISM Non-Manufacturing PMI data release for November from the U.S. set the course of the Dollar’s trajectory in the week that commenced on Monday, December 5. The unexpected rebound in the services PMI to 56.5, from the more than 2-year low of 54.4 in October, reignited monetary policy tightening fears and came to the Dollar’s rescue. The Dollar Index (DXY) – a measure of the Dollar’s relative strength against six currencies – which had opened the week at 104.51 and fallen to a multi-month low of 104.11, surged to 105.29 by close on Monday.
The resilience of the dominant services sector rekindled fears of the Fed continuing with its tight monetary policy, lifting the DXY to as high as 105.82 by Wednesday. Despite these, the DXY finally finished the week at 104.81, a marginal gain from the previous Friday’s close of 104.54 amidst renewed recession fears and warnings from a few big banks. The DXY is currently at 104.69.

The 25-basis points rate hike by the Reserve Bank of Australia on Tuesday and warnings of further rate hikes amidst persistent inflation, helped the AUD/USD pair rise to 0.6795 by Friday, December 9 from 0.6789 on Friday, December 2. However, anxiety ahead of the Fed’s decision has dragged the pair to its current level of 0.6773.

The EUR/USD pair closed the week ended December 9 on a sober note, dropping to 1.0530 from 1.0538 a week earlier, despite impressive industrial production numbers from Germany. The euro ranged between $1.0596 and $1.0443 during the week. The pair is currently at 1.0567.

The pound too depreciated against the Dollar during the week ended December 9. The GBP/USD pair which opened the week at 1.2266 dropped to 1.2255 by Friday, after oscillating between 1.2346 and 1.2105. The pound is currently trading at $1.2290.

Markets are seen waiting cautiously for the U.S. CPI data release as well as the Fed’s policy review. Also on the anvil are monetary policy meetings by the Bank of England, the European Central Bank, the Swiss National Bank, and the Bank of Mexico, as well as inflation data releases from UK, India, and South Africa.

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