Markets ignore CPI uptick, Mideast tensions could fuel haven and oil-related FX Markets ignore CPI uptick, Mideast tensions could fuel haven and oil-related FX Markets ignore CPI uptick, Mideast tensions could fuel haven and oil-related FX

Markets ignore CPI uptick, Mideast tensions could fuel haven and oil-related FX

Forex 6 minutes to read
Charu Chanana

Head of FX Strategy

Summary:  Markets shrugged off the uptick in US inflation beyond the initial knee-jerk reactions that were later reversed. Focus quickly turned to risks of escalation in the Mideast conflict with US and UK launching airstrikes. Oil up 2% could fuel upside risks in NOK and CAD. Safe haven like JPY and Gold also on watch going into the weekend, while AUD could be temporarily lifted by China rate cut bets.

USD: Downside in focus as Fed pivot bets accelerate

US December CPI reaffirmed that the last leg of disinflation is proving bumpy as headline inflation rose and core did not cool as expected. Both headline and core rose 0.3% MoM (vs. 0.1% and 0.3% respectively earlier) while the headline YoY rose 3.4% from 3.1% in November and 3.2% expected. Core was at 3.9% YoY from 4.0% previously, but higher than the 3.8% expected. Core goods prices were flat after being in decline for the last six months. Core services inflation eased a notch, but shelter inflation, which the market has been waiting to come down, rose by 0.4% MoM, remaining elevated at 6.2% YoY but lower than 6.5% last month. Services less rent rose 0.6% MoM and 3.5% YoY.

However, the reaction function of the markets was very different from what one would expect. Ideally such an uptick would question whether a March rate cut is really likely and could instil some fear on whether the Fed meeting at the end of this month would signal willingness to cut rates. But none of that happened. Instead, March rate cut bets have jumped. This could mean two things:

  1. Markets have moved away from worrying about inflation – Disinflation relief reigns even as December CPI has highlighted that the last mile of getting to the 2% inflation target could be bumpy and Red Sea disruption risk fuelling some price pressures amid shipping delays and risks of escalation. But one month of higher inflation doesn’t disrupt the path of disinflation, and the Fed really focuses on core PCE and not CPI.
  2. Markets have moved away from worrying about interest rates – With QT cycle being over, liquidity will be the key tool for the Fed rather than interest rates.

The dollar index bumped higher on the inflation release, but reversed later and closed Thursday’s session nearly unchanged. Downside pressure on the dollar could remain intact as markets continue to expect rate cuts, and PPI due today or retail sales next week could mean little. However, watch for any escalation risks in the Mideast tensions as discussed below, as that could fuel haven buying which may support the dollar. DXY index is testing 102, which has held up on several tests over the last two weeks. A break below could bring focus on 76.4% fibo retracement levels at 101.42 and December lows of 100.62.

DXY Index. Source: Bloomberg, Saxo

NOK, CAD, AUD: Yemen strikes boost commodity-related currencies

Oil prices nudged higher on reports of US and UK airstrikes against Houthi rebels in Yemen. This comes after Iran also raised stakes as its Navy captured an oil tanker off the coast of Oman, and raises risks of an escalation in Mideast tensions especially going into the weekend. This could keep focus on commodity-related currencies. EURNOK is particularly exposed with December lows of 11.18 in focus.

AUDUSD has also pushed above 0.67 and could remain supported as energy prices see upside risks on geopolitical concerns. Expectations of a rate cut from China next week also adds a layer of support for AUD into the next week, but a break of 21DMA at 0.6754 will be needed for upward bias to return. Aussie data over the last week has shown demand concerns, with November CPI and imports both coming in below expectations. If Q4 CPI out on 31 January also shows a similar pattern, that could fuel a reassessment of RBA rate cuts, which is currently priced to be less dovish than other major central banks this year.

Gold, JPY: Yen waiting for bonds to continue the rally, geopolitics on watch

Bonds also shrugged off the US inflation report and yields were lower on the day. That helped yen to recover after an initial run higher in USDJPY to 146+ levels. USDJPY tested a break below 145 in the Asian session today but could not sustain, as Treasuries pared some of the overnight gains. As bonds are likely to continue to rally this year, it appears that market participants used the decline in bonds following the CPI as an excuse to add exposure. If Treasury yields maintain this downside bias, there could be reasons for yen to rally. However, paring of BOJ pivot bets following the earthquake in Japan has pushed yen lower in recent weeks. Any moves in USDJPY to 146+ levels is likely to continue to attract sellers. EURJPY could also be key with ECB’s Lagarde declaring a victory over inflation, and seemingly waiting for a green light from Powell to start cutting rates. EURJPY shorts could also gather with any moves above 160.

With near-term focus on geopolitical escalation risks, yen and gold could see safe-haven buying. Gold has been range-bound lately, but 50DMA at $2,015 is serving as a solid support.


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