US January CPI figures have made uncomfortable reading for the Federal Reserve. A core inflation reading of 0.4% month-on-month and nearly 4% year-on-year is not a good look for a central bank preparing to cut rates. It is no surprise that the December 2024 Fed Funds futures contract sold off 24 ticks yesterday and the market has scaled back expectations for 2024 Fed easing to 90bp from a view of 160bp just three weeks ago. As our US economist James Knightley discusses here, the seeming divergence between the CPI numbers and the Fed’s preferred measure of inflation – the core PCE readings – will only confuse the Fed. And clearly, these numbers are not giving the central bank the kind of confidence it needs to declare that the inflation battle is over. Add in the fact that January’s US jobs data was strong across the board as well, which also brings into question the Fed’s position that the US labour market is coming back into better balance.
The strong inflation print generated a predictable market reaction – a bearish flattening of the US yield curve, weaker equities (especially growth stocks), and a stronger dollar. Looking across the FX space on a total return basis, the dollar is the strongest performer in the G10 this space this year and is only bettered (marginally) in the EM space by the Turkish Lira, Indian rupee, and Mexican peso. Given seasonal patterns favour the dollar in February and that the next big input into the Fed equation, the January PCE data, is not released until 29 February, it looks like the dollar will be able to hold recent gains for another couple of weeks. DXY can trade on the firm side of a 104.60-105.00 range today.
Elsewhere, the broad-based dollar rally has taken USD/JPY well above 150. Because this is a dollar rather than a yen-led move, the consensus view is probably that Japanese authorities will not be able to justify any FX intervention. We are not so sure and suspect the US Treasury would again accept Japanese intervention to sell USD/JPY should it make a quick move to 152. At just 7.45%, one week USD/JPY implied volatility seems too low in that intervention cannot completely be ruled out.
Chris Turner
