Fear has returned to the market. After the U.S. inflation statistics for January were released, investors had nowhere to hide except in the U.S. dollar. Stock indices marked the most significant sell-offs on the day the consumer price data came out since September 2022. Bonds were deflated by inflation, and their yields surged. This allowed the "bears" on EUR/USD to push the pair below 1.07 for the first time since mid-November. On the contrary, the VIX fear index jumped to its highest level in three months. Has the market greed come to an end?
Market Indices' Reaction to U.S. Inflation
In reality, there is nothing surprising about what happened. Core inflation remained at 3.9% YoY, and it is still very high for the Fed to afford to relax. Markets are increasingly leaning towards the idea that the December FOMC forecasts of three acts of monetary expansion in 2024 are the most accurate prediction of the fate of the federal funds rate. As a result, the dollar is winning, and the stock market is losing.
The resilience of the latter to the rise in Treasury bond yields and the reassessment of the Fed's monetary policy easing chances since the beginning of the year was surprising. If the S&P 500 rally in the fourth quarter was logical against the backdrop of falling U.S. debt market rates, its continuation in conditions of their rise looked like an anomaly. Investors seemed to think that the dog was buried in a strong economy, but its strong positions increased the risks of inflation acceleration and keeping the federal funds rate at 5.5% for an extended period.
Most likely, the market stubbornly believed that consumer prices would continue to confidently move towards the 2% target. Greed was overwhelming; a trigger was needed for the pullback of stock indices. Investors received it in the form of a surge in service inflation by 0.7% MoM in January. The neat theory that the growth rates of CPI and PCE would continue to decline as supply chains recovered collapsed, dragging EUR/USD into the abyss.
U.S. Inflation Dynamics
What's next? Retail sales and producer price data will complete the picture. The first indicator characterizes the strength of consumers, the main driver of economic growth. Its expansion in January will increase the likelihood of further GDP expansion, further fueling demand for the U.S. dollar due to American exceptionalism. The fate of CPI will depend on the dynamics of PPI. Whether Goldman Sachs is right in calling the surge in January inflation a temporary phenomenon or not will be shown by the data.
In any case, the fate of the main currency pair will depend on the market's revision of views on the timing and scale of the Fed's monetary expansion. And for this, new U.S. statistics are required.
Technically, the rebound of EUR/USD from dynamic support in the form of a moving average allowed to increase previously formed shorts on the breakdown of support at 1.0755. The target remains the same – 1.064. However, the pair may go lower, towards 1.058. The focus is on selling.
