FX Trading focus: US yields shrug off hot US CPI data, USD breaks lower.
The US December CPI registered its highest headline inflation in nearly forty years – largely as expected, but with the month-on-month figures surprising slightly to the upside at +0.5%/+0.6% ex Food and Energy month-on-month and the ex Food and Energy year-on-year at 5.5% (vs. 4.9% in November), while the headline year-on-year level was the expected +7.0%. More interesting is that this latest data point seems to have revealed that Fed expectations have gotten about as high as they can recently as policy expectations for the coming one-three years and even long US treasury yields have consolidated rather sharply through the last couple of days and despite this data and hawkish talk from now “four hikes in 2022” Bullard of the St. Louis Fed. AS well, the US dollar was stung for sharp losses, including an important technical break higher in EURUSD and bearish reversal in USDJPY.
Yesterday’s action would seem to suggest that Fed expectations are not worth much for the US dollar, which fell across the board as many commodities also surged, perhaps in reflexive fashion. That would suggest that the US dollar’s only remaining card would be on a new round of safe haven seeking if risk sentiment rolls over again. Either that, or we would need to see the Fed’s perceived “terminal rate”, the rate at which the market is pricing the coming Fed rate hike cycle. If those who suggest the balance sheet reduction will prove the policy option that asset markets are unable to absorb without a tantrum, then perhaps the Fed never gets. Until then, the political need to be seen as getting ahead of inflation will keep the Fed on track to hike soon and possibly hike more than the market is expecting for the coming year.
Regardless, the US dollar has broken stronger until proven otherwise – continued strength in commodities and strength in asset markets would likely see a continuation, while weakening risk sentiment would see perhaps stronger G3 versus the rest.
The EURUSD super-major burst through very well-defined resistance at 1.1386 yesterday that had capped the action for the pair since late November as the US dollar weakened sharply in the wake of the December CPI release yesterday, clearly a sign that it is difficult to shift the market’s level of the Fed’s “terminal” policy rate for the coming rate cycle beyond the 2.0% area. The next key resistance area looks like 1.1500-25, the prior range lows before a significant meltdown on November 10 – ironically the day that a hot US October CPI release triggered a major reassessment of the potential for the Fed to hike more this year. The break of the downward trend-line has softened up the longer term down-trend at minimum.