Persistent inflation reignites the USD

Panic spread across markets after data that ruled out the Fed starting easing as early as its March meeting. Inflation in the US slowed down in January much weaker than forecast. CPI dynamics slipped from just 3.4% to 3.1% year-on-year, with the expected first reading below 3% year-on-year since spring 2021. Core inflation maintained its annual growth rate of 3.9% year-on-year. Disinflation is not gaining momentum: core prices jumped by as much as 0.4% month-on-month. The US dollar gained almost 1% against the euro, but the EUR/USD remains above December's low at 1.07.

The US dollar: Fed rate cut in May still possible

Looking from a broader perspective, the strength of inflationary pressures has been recently consistent with the Fed's target. Yesterday's data do not necessarily imply a break in positive trends. Housing costs are responsible for the larger-than-forecast jump in core inflation. This may not be a sustained phenomenon as rents have started to decline markedly, which will gradually be reflected in the CPI data. Secondly, in the Fed's preferred price pressure measures, these categories have smaller weights.

Interest rate cuts in the US from the 5.25-5.50% range that has been in place since July last year will begin as soon as the belief is firmly established among FOMC members that this is a sustainable trend. Yesterday's data are definitely not a step in that direction, but fintech Conotoxia's forecasts still assume that a cut will occur in May. Monetary policy easing should end the US dollar's correction-bearing rebound and highlight the PLN's strengths. This seems even more likely given that the MPC is unlikely to decide to resume interest rate cuts this year.

The US dollar: lack of progress in the fight against inflation prolongs USD dominance

Central banks misjudged the persistence and strength of price pressures after the pandemic. The US monetary authorities, mindful of this lesson and aware that their credibility is at stake, want to avoid making a mistake again, this time by cutting interest rates prematurely. Recently, the Federal Reserve has been able to convince investors that it will not start easing as early as March, and the chances of a first cut in May were valued at around 50% yesterday morning. After the publications, the probability of such a move decreased to 30%. The realisation of inflated expectations favoured a rebound from last year's USD overvaluation. The US dollar has made the strongest gains among the major currencies in the first few weeks. The EUR/USD plunged again to 1.07 after the readings, but the December lows have so far still not been pushed.

The market sway has been successful with encouraging news from the US economy. There is definitely no rush due to the growing risk of recession. On the contrary, sentiment in industry and services is not weakening, and non-farm employment has grown by an average of almost 290,000 payrolls in the past three months. However, rate cuts are inevitable due to decelerating inflation, which should continue to decline in the wake of gradually falling rents and weakening consumption. CPI dynamics should already decline to around 2% year-on-year by the mid-year, leaving the Federal Reserve with an open path to support economic growth through interest rate cuts. In such a scenario, the downward trend in the dollar would resume. Fintech Conotoxia's currency forecasts assume that the EUR/USD will reach new trend highs later in the year.