The USD's puzzling behavior raises questions as to why it is depreciating despite a resurgence in US inflation. The dollar had pinned its hopes on the December inflation report to reassure traders that cutting rates prematurely was unwarranted. Surprisingly, even though the data exceeded expectations, traders increased the likelihood of a March rate cut, causing a decline in the greenback across the board.
Following the market's digestion of the information, the probability of a March rate cut by the Fed surged to 73.2%, up from less than 65% the previous day. This dovish shift in investor expectations contributed to the USD's decline, reversing its initial reaction to the inflation report, where it briefly rose to 102.76.
Consequently, the DXY index slipped 0.05% against a basket of currencies, closing at 102.29. The dollar also lost ground against the euro (down 0.1% to 1.09820), the pound (down 0.17% to 1.27630), and the yen (down 0.2% to 145.48), with USD/JPY reaching its highest level since December 11 at 146.10.
The USD continued to trade in the red zone against major rivals amid expectations of further inflation data. If the Producer Price Index (PPI) in December shows a decline, reinforcing the notion of receding US inflation, speculation about an earlier Fed monetary reversal may intensify, accelerating the USD's decline.
Examining Thursday's statistics sheds light on the resurgence of the March rate cut scenario and the subsequent USD pullback. Despite a momentary rise in the USD, driven by positive overall inflation news, a deeper look reveals a monthly jump of 0.3%, surpassing economists' 0.2% prediction. The annualized gain also exceeded expectations, rising from 3.1% to 3.4%, the highest level in three months.
Analysts attribute this unexpected inflation spike to various factors, including a slower decline in energy prices in December (2% compared to -5.4% in November) and a substantial increase in housing sector prices, including rents, hotel stays, and motels (0.5% jump in December). The rebound in prices for used cars and clothing also contributed to the overall inflation growth.
If the market witnesses further evidence of substantial progress against rising prices, it could strengthen the dovish sentiment surrounding the Fed's future policy. In such a scenario, the USD might continue its decline, while the euro, pound, and yen could strengthen. It appears probable that the Fed will adopt a more dovish stance over the next two years, especially given its higher initial rate range compared to the Eurozone, for example.
This article was written in cooperation with TradingView