The mixed U.S. inflation report, released at the start of the American trading session, raised more questions than it answered. While the headline Consumer Price Index (CPI) met expectations and indicated an acceleration in overall inflation, the core CPI fell into the "red zone," suggesting a deceleration in this key measure. In response to the report, the EUR/USD pair remained around the 1.03 level, even testing the resistance level of 1.0350, which corresponds to the middle line of the Bollinger Bands indicator on the daily chart.
But is the latest report truly detrimental for the dollar? And are long positions in the current fundamental climate truly reliable? These are important questions to consider.
There's a Latin expression, "In dubio pro reo," which means "when in doubt, for the defendant." Rephrased, it suggests that traders are currently interpreting their uncertainties in a way that favors a weaker dollar. For example, the Producer Price Index (PPI) report released on Tuesday showed upward movement for the third consecutive month, increasing by 3.3% year-over-year, although this was slightly below the forecast of 3.5%. This marks the fastest growth rate since March 2023. However, the core PPI remained steady at 3.5%, aligning with predictions. Despite the evidence of rising inflation, the market interpreted this information negatively for the dollar, influenced by the overall pessimistic tone of the report.
A similar situation occurred on Wednesday when the headline CPI rose to 0.4% month-over-month, the highest increase since March 2024, and representing the second month of growth in a row. Year-over-year, the headline CPI climbed to 2.9%, marking the strongest growth rate since July 2023. This indicates a positive trend after six consecutive months of declines earlier in the year, from April to September.
In contrast, the core CPI, which excludes food and energy prices, has entered what is referred to as the "red zone"—a situation different from the overall CPI, which met the forecast. Monthly, the core index dropped to 0.2% after remaining at 0.3% for four consecutive months. On an annual basis, this indicator also decreased to 3.2%. While it may seem that both components are showing a decline, it's important to highlight that the core CPI experienced a significant drop from April to July, reaching the target of 3.2% by mid-summer. In August, it held at this level. However, from September to November, the core CPI rose slightly to 3.3%, before returning to 3.2% in December. This indicates that there is no real downward trend; instead, the core CPI appears to be stagnating at a relatively high level, which remains concerning for the Federal Reserve.
The inflation report also reveals an increase in energy prices in the U.S., which rose by 0.5% after a previous decline of 3.2%. The cost of natural gas surged by almost five percent (4.9%), following a 1.8% increase in November. Additionally, food prices increased significantly, rising by 2.5% (compared to 2.4% in November). Transportation services also saw a rise of 7.3%, after having increased by 7.1% previously. Meanwhile, both new cars and used cars experienced slight price decreases, falling by 0.4% and 3.3% respectively.
The data indicates that overall inflation continues to rise, though not as sharply as some analysts had anticipated. Meanwhile, core inflation appears to have stalled, with no signs of a downward trend emerging at this time.
The market's response to the CPI and PPI data has been overly emotional. Many traders seem to believe that milder inflationary pressures would allow the Fed to adopt a more aggressive pace of monetary policy easing this year. It's worth noting that the dot plot forecast updated in December anticipates two rate cuts of 25 basis points in 2025. However, these conclusions are, in my opinion, premature and unfounded. The US labor market remains strong, and inflation indicators are either accelerating or demonstrating persistence, rather than showing a sustainable decline.
Market expectations regarding the Fed's actions have remained largely stable. The probability of no interest rate change at the January meeting stands at 97%, while the likelihood for March is at 72%, according to CME FedWatch. Currently, there is a 50/50 chance of a 25-point cut in May, down from a previous estimate of a 60% chance for a pause in that month. However, since there are still five months until the Fed's May meeting, discussing such distant prospects is somewhat premature.
Recent inflation reports did not lead to a rally in the dollar, but they also did not cause a significant decline, as the data continues to show rising inflation in the U.S. Current price increases in the EUR/USD currency pair should be viewed as opportunities to enter short positions, especially if buyers struggle to break through the interim resistance level at 1.0350, which is the middle line of the Bollinger Bands on the daily chart.
The first target for a downward movement is the 1.0300 mark, represented by the Tenkan-sen line on the daily chart, while the main target is the 1.0230 level, which corresponds to the lower line of the Bollinger Bands on the same timeframe.
