- Despite The Federal Reserve’s firm stance, markets remain hopeful for a shift in policy.
- Predictions are that the United States Consumer Price Index will drop to 6.5% in December, a yearly decrease.
- Inflation data will likely cause noteworthy effects on the EUR/USD and USD/JPY exchange rates.
The US Federal Reserve’s Summary of Economic Projections (SEP), released following the December policy meeting, suggested that policymakers expect a more gradual approach to rate hikes in light of soft inflation readings. On Thursday, January 12th, the US Bureau of Labor Statistics will be releasing December’s Consumer Price Index (CPI), which is expected to show a decline in the annual CPI from 7.1% in November to 6.5%, while the Core CPI excluding the food and energy prices is forecast to edge lower to 5.7% from 6%. The CME Group FedWatch Tool currently estimates an 80% chance of the Fed raising its policy rate by 25 basis points in the month of February to a range between 4.5-4.75%.
Investors are looking for clues on how aggressive the Fed will be in future rate hikes and whether they will pivot away from their current stance. Recent activity in US Treasury bond yields and the US Dollar Index suggests that investors are not convinced that the Fed will stick with its current stance and see further tightening as unlikely as inflation readings remain weak.
For investors to gain a better understanding of how the markets will respond following this report, they need to look beyond just the overall Core CPI reading and consider other details within it, such as the “Services less energy services” item, which rose 0.4% in November and stood at 6.8% on a yearly basis. This component could give insight as to whether or not any losses seen on the US Dollar can be long-lasting; if this component increases at a strengthening pace despite lower-than-expected monthly Core CPI readings, then short-term effects on USD should be limited.
A hot Core CPI reading combined with a strong increase in “Services less energy services” should cause investors to reassess risk appetite towards future rate hikes, triggering a steady recovery in USD value. Inversely, if inflation numbers are weaker than expected, then this could weigh heavily on USD value across currency pairs such as EUR/USD or USD/JPY. These pairs offer better trading opportunities than GBP/USD, given that Europe Central Bank adopted a hawkish stance after its December meeting. The Bank of Japan may take tightening steps into 2023. Bank of England has made it clear that it is nearing the end of its tightening cycle.
Meanwhile, gold prices have been benefitting from retreating US T-bond yields, poised for new multi-month highs near $1,900 should T-bond yield drop below 3.5% after data release – capping off what looks set to be an interesting start for 2023 following this month’s inflation report from BLS scheduled for Thursday, January 12th, 2023.
