The US dollar tumbles as inflation cools down (Daily analysis 13.07.2023)

The US dollar index tumbled towards the 100.00 mark to trade at the lowest levels since March 2022 as June inflation data came in below estimates and undermined the belief that the Federal Reserve will be able to hike rates both in July and September. The EUR/USD rate has finally breached 1.11. Currencies that underperformed in the year's first half, namely JPY, NOK and SEK, skyrocketed in July. The USD/JPY slipped from the 145 area and has recently dived 5 pct.

The US dollar: disinflation accelerates and hits the USD

Last June, US prices rose the fastest in four decades, at more than 9% y/y. Exactly twelve months later, CPI growth slowed from 4.0 to 3.0% y/y, the lowest since March 2021. The easing in consumer inflation is not enough to deter the Fed from its announced continuation of tightening. Indeed, the problem remains core inflation and stubbornly expensive services. The index excluding food and energy peaked at 6.6% y/y three months later than the CPI and, since then, has slowed down very reluctantly. Only in June did it fall from 5.3 to 4.8% y/y, and its monthly change came in below forecasts for the first time since the publication of last November's data.

Nevertheless, there is little doubt that at its meeting in a fortnight's time, the Federal Reserve will resume the interest rate hike cycle after its June pause. The probability that the cost of money will rise to the highest range since the first quarter of 2001 of 5.25-5.50% is estimated at almost 90%. Investors are primarily concerned about the steps of both the Fed and the European Central Bank after the summer. It is within this context that all information coming out of the economies is already being considered.

The US dollar: USD exchange rate forecasts assume further decline potential

The market is currently pricing the chances of the ECB's deposit rate hitting the 4 per cent ceiling for the first time in history in September at close to 70 per cent. Although the US economy is in better shape and growth in Euroland is disappointing, after yesterday's data, the probability of an additional hike by the Fed is estimated at less than 15%. The maintenance of a tight stance by members of the Open Market Operations Committee (FOMC) and the insistence that, according to June projections, the optimal solution is to raise interest rates twice may be perceived positively. Making expectations for future Fed moves more realistic has the potential to temporarily support the sharply overvalued dollar this summer, slowing its weakening.

Although there is a risk of a summer correction of the dollar exchange rate, Conotoxia's currency forecasts consistently assume that in the second half of the year, the EUR/USD will settle above 1.10 and at the end of the year, it will be in the vicinity of 1.12. After the finalisation of the rate hike cycle, the progressive deceleration of economic growth in the USA, the continuation of disinflation and the deterioration in the condition of the labour market should hit the USD in the fourth quarter. Especially if, thanks to a new dose of stimulation, economic growth in China shakes off its recent slowdown.