US inflation puts the brakes on sharply, USD in freefall, EUR/USD touched the 1,10 handle (Daily analysis 13.04.2023)

In March, US consumer prices were 5.0% higher than a year earlier. This is the weakest price growth since spring 2021. Inflation was 6% y/y in February and reached its highs in June last year at 9.1% y/y. The dollar suffers from rapid disinflation, and risky currencies lure investors. The US currency is more than 10% cheaper than it was six months ago, when the USD was starting to slide from its highs.

US dollar: USD depreciation speeds up after inflation data

As in many other economies, a large part of the statistical effects associated with last year's shocks and the spike in fuel prices following Russia's attack on Ukraine is responsible for the decline in the US price growth rate. However, price pressures are instead continuously visible at the core inflation level. This index accelerated in March for the first time since September and jumped from 5.5 to 5.6% y/y. Yesterday's data came in above market forecasts for consumer inflation and were in line with expectations in terms of core inflation. The readings for March do not necessarily imply that the Fed's March interest rate hike was the last.

We expect the cycle to be completed at the meeting on 3 May with a move of 25 basis points to a range of 5.0-5.25%. Such a scenario also seems most likely in light of yesterday's release of the minutes of the March FOMC meeting, in which the monetary authorities were warned that a mild recession could begin in the third quarter. Historically, it has taken an average of just a few months for the Federal Reserve to start lowering the cost of money. Investors fear a sharp downturn in the US, the risk of which is heightened by the emerging tensions in the US banking sector. As a result, they are taking bets that history will repeat itself. In their view, rates will be cut before the end of the year due to the economy hitting the brakes. For the time being, it remains a wave of the future, and the fact is that core inflation is persistent.

Regardless of whether the Fed eventually moves to ease policy in the coming months, the stance of US monetary authorities having to take financial stability risks more firmly into account should be softer than the course taken by the European Central Bank. Uncertainty about the prospects for US economic growth, combined with a more optimistic outlook for the eurozone, is another sign in favour of deepening dollar weakness. Conotoxia's dollar exchange rate forecasts expect the EUR/USD pair to settle above 1.10 this year.

US dollar: inflation in the US will only subside quickly in the event of a deep recession

Market forecasts assume that disinflation in the US will continue in the coming quarters but that price indexes will only approach the inflation target in 2025. The path to a more rapid cessation of price growth is only possible through a deep recession. Tensions in global supply chains are dying down, as evidenced by the collapse of ocean freight costs and their return to pre-pandemic levels. Aside from the weakening of the shock in the form of a sharp jump in energy commodity prices, this is a factor holding back commodity prices. In this situation, services, which are the most reliable reflection of the strength of consumption and the power of the labour market, become the key to bringing inflation under control.

How sharply inflation fades in the months ahead will also depend largely on car prices and rents (which are included in the very important shelter category). In the first case, the normalisation following the pandemic shot may have come to an end when chronic problems with the supply of new and used vehicles were recorded. In the second, a gradual reduction in rates is expected to follow with a delay in relation to the cooling of the property market induced by the Fed rate hikes. Even now, the observed dynamics are lower than in 2022.

As is the case globally, food prices are likely to drive disinflation in the coming months. The FAO index, which measures them globally, has been falling steadily for a year and is more than 20% below its March 2022 high. Following the announcement of OPEC + oil production cuts, it is clear that producers will not tolerate crude prices below 75 USD per barrel. As a result, gasoline prices in the US are not expected to fall permanently and firmly below 4 USD per gallon. At least until December, they will be lower in each month than the same period in 2022, but at the same time the chances that fuels will contribute to a faster phasing out of inflation are weakening.