Sovereign International Daily Market Report
Dollar advances after strong US inflation report
Highlights:
The dollar rose against most currencies on Thursday, after the latest US inflation report eased bets in favour of a March interest rate cut from the Federal Reserve.
Headline consumer prices increased by 0.3% on the month in December, and by 3.4% relative to a year previous - the fastest pace in three months. The drop in annual energy prices slowed, and inflation in the shelter and transportation components remained sticky. While the critical core inflation measure, which strips out volatile items such as food and energy, continues to ease from its highs (3.9%), the downward trend in this measure also appears to have stalled, with this metric coming in above the 3.8% pencilled in by economists.
We think that the stubbornness evident in underlying inflation, in particular, will be a cause for concern for FOMC officials, particularly at a time when the US labour market remains near full employment, and has only shown modest signs of cooling. This jobs market strength was evident once again in the latest initial jobless claims data, which also beat estimates on Thursday. Weekly claims fell to 202k in the week to 05/01, with the four-week moving average now at around its lowest level since February last year.
Investors reacted to yesterday’s news by sending the greenback higher against most currencies, albeit the move was relatively modest, with EUR/USD merely back trading at Wednesday’s levels by the close of the London session. We see potential for some further near-term upside in the dollar should Fed members continue to cast doubt over the possibility of a first US rate cut at the bank’s March meeting, which remains largely priced in by futures markets. As things stand, we are eyeing a start to Fed easing in June and see a less aggressive pace of US rate cuts in 2024 than currently priced in by financial markets.
BoE’s Bailey provides no clues on UK policy easing
The pound has continued to outperform its major counterpart in the past few trading sessions, buoyed by expectations that the Bank of England will keep interest rates higher for longer than most of its major peers. As expected, BoE governor Bailey issued no change in the bank’s stance during his parliament hearings on Wednesday. Bailey stressed the importance of achieving the bank’s inflation mandate, while saying that mortgage rates were not as stretched as they were during the financial crisis. Importantly, there were no signs of a dovish pivot, and no evidence that the bank is considering lowering the base rate any time soon. Futures markets are still largely pricing in the first BoE cut in May, although this morning’s GDP data could go a long way in shifting these expectations.
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In the Euro Area, European Central Bank member de Guindos warned over a slowdown in growth in the common bloc in Q4 during his speech on Wednesday. During his rather downbeat assessment, he said that soft indicators of activity were pointing to a technical recession in the final three months of the year, while saying that prospects for near-term growth were ‘weak’. However, he also said that the slowdown in consumer price growth would ‘pause temporarily’ at the beginning of the year. De Guindos’ comments on inflation, and a warning from fellow member Schnabel that now was ‘too soon’ to discuss rate cuts, have provided a bit of support for the euro, which has lagged behind only sterling in the G10 in the past week.
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