The US dollar exchange rate dived sharply on Tuesday. Stocks and bonds rose markedly, completing the picture of a euphoric market reaction to the low US inflation reading, which led investors to no longer believe that the Fed can continue its rate hike cycle. The US dollar lost more than 1% against the euro and the pound.
Inflation in the US slowed from 3.7 to 3.2% year-on-year, while the core index fell from 4.1 to 4.0% year-on-year. A strong, near double-digit drop in fuel prices contributed to consumer prices not rising from the previous month for the first time since July 2022. However, price pressures in key Fed services are also easing. Housing spending recorded a smaller increase than last time.
Tuesday's lower-than-forecast readings virtually doom the chances of the Federal Reserve deciding to hike rates in December. The US currency depreciated sharply immediately after the data. The EUR/USD surpassed 1.08.
The next few months should bring a deepening of the USD depreciation. The dollar has been strong lately as the US economy remained bullish. At the same time, the Eurozone was looking recession in the eye. This unambiguously positive characteristic of the US currency is significantly losing ground as divergences in the condition of the economies begin to blur.
The most recent data from Germany may be a sign of improvement on the Old Continent. The component of the ZEW index reflecting expectations rose from -1.1 to 9.8 points for the fourth consecutive month, beating market forecasts.
Looking back to the dollar situation, by March 2022, interest rates in the US had been raised by a record 525 bps and to a range of 5.25-5.50%. Next year, the economy will start to catch an increasingly obvious breath under the impact of the increases made in the past several months, and CPI dynamics will probably fall below 2% year-on-year. With decelerating leading measures of inflation, the Fed will soften its stance and start cutting interest rates to support the labour market. Conotoxia's dollar exchange rate forecasts assume the EUR/USD will settle above the 1.20 handle next year.