The dollar is back on top. The US inflation report was on the side of dollar bulls, making it possible for sellers to push the pair towards the 1.7 level. However, inflation in January did not accelerate; on the contrary, it slowed down on an annual basis. In general, this is why the pair is reacting in a somewhat restrained manner to the report.
In my opinion, traders are somewhat underestimating the significance of the report. After all, representatives of the hawkish wing of the Federal Reserve have strong arguments to defend their position. The prospects of a Fed rate cut at the May meeting are gradually fading, and the horizon of events is shifting further towards the summer meetings. We can say that the inflation data worked as a time bomb, which will detonate a little later, when Fed officials comment on the report.
The Consumer Price Index (CPI) increased 0.3% last month, against a forecast of 0.2%. This indicator shows an upward trend for the third consecutive month (November – 0.1%, December – 0.2%, January – 0.3%) after dropping to zero in October. In annual terms, the overall CPI was also in the "green," rising to 3.1%. From a formal perspective, this component of the report demonstrated a downward trend again. However, the fact is that most analysts predicted a more significant decline – to 2.9% after rising to 3.4% in December.
The core Consumer Price Index, excluding food and energy prices, also exceeded consensus estimates. On a monthly basis, the indicator rose to 0.4% – the strongest growth rate since May 2023. On a yearly basis, the core CPI remained at the December level, i.e., at 3.9%. Whereas most analysts predicted a decrease to 3.7%.
The report also indicates that energy prices in January dropped by 4.6% on an annual basis (compared to a 2% decline in December) – with gasoline declining 6.4%. The growth rate of the cost of new cars slowed to 0.7% (compared to 1% in December), food – to 2.6% (compared to 2.7% in December), clothing – 0.1% (1%), medical goods – to 3% (compared to 4.7% in December), and transportation services – to 9.5% (compared to 9.7%).
Nevertheless, even if inflation slowed down, the market focused on the dynamics of the decline in core indicators. Traders immediately reacted to this report. Futures quotes on US stock markets fell, and the US Dollar Index moved higher. In particular, the Dow Jones Industrial Average index, an hour and a half after the release, declined by 0.90%, the S&P's 500 dropped by 1.20%, and the Nasdaq Composite lost 1.9% (company reports also played a role here, but the inflation report served as a "trigger"). In turn, the US Dollar Index sharply soared and reached a three-month high (104.76).
The EUR/USD pair reacted accordingly. However, here, traders' reaction was more modest. Bears dropped towards the 1.7 level, but they did not dare to storm the 1.6 level. EUR/USD traders are assessing the consequences of the report and traditionally expect help, i.e., statements from the Fed.
The Fed will play a decisive role here: either the members of the central bank will be concerned about the fact that inflation has not decelerated markedly, or they will focus on the simple fact that inflation has slowed down. In my opinion, the first scenario is more realistic. Fed officials will likely tighten their rhetoric, casting doubt on the feasibility of monetary easing in the coming months. In this case, the May meeting will be "under attack," as the results of the March meeting are already predetermined (the central bank will keep all policy parameters unchanged).
However, the market has already drawn its own conclusions without waiting for comments from the Fed. Investors pegged a 35% chance that the Fed would cut rates at their meeting in May, according to CME Group's FedWatch tool. Before the inflation report was published, this probability was 55%. If Fed officials are concerned about the pace of inflation slowdown (which is very likely), market expectations will shift again – this time to June. By the way, a similar story happened with the March meeting. At the end of December, the market was 80% certain that the Fed would take the first step towards easing monetary policy in March. However, mixed inflation data for December and the January Non-Farm Payrolls reduced this probability to the current 8%. We can assume that the same fate awaits the May meeting.
In my opinion, the bears received a powerful fundamental advantage that has not yet fully unlocked its potential. In the current conditions, buying is inherently unreliable, while selling makes sense after EUR/USD bears break through the support level at 1.0720 (the lower line of the Bollinger Bands indicator on the daily chart) and consolidate below it. The next target for the downward movement is the 1.0610 level – the middle line of the Bollinger Bands on the monthly timeframe.
