The drop of the U.S. inflation to 5.0% year-on-year in March from 6.0% a month earlier convinced bears to sell the Greenback. If inflation is proven to be going down the Federal Reserve (Fed) has no more arguments to hike its interest rates. The Federal Open Market Committee (FOMC) Minutes clearly showed Fed members’ fear a possible mild recession later in 2023 after a banking crisis broke out in March.
Core Consumer Price Index (CPI), that excludes volatile items like fuel and food, grew by 5.6% year-on-year in March, up from 5.5% in February. Thus, a decline in Headline inflation could be attributed to lower crude prices during the banking turmoil. WTI prices dropped by 20% from March 6 through to March 20 to $64.2 per barrel. Nevertheless, prices have recovered some of the losses, ending March at $75.5 per barrel. Without this fluctuation of crude prices, headline inflation was likely to be up above February’s level.
WTI prices were boosted above $80 per barrel in early April by the Organisation of Petroleum Exporting countries and their allies, known as OPEC+, decision to cut production. So, low crude prices will no longer have the downside effect on prices. On the contrary, fuel prices are expected to rise during April, which will be very sensitive for Americans.
Huge money injections by the Fed in order to tackle the banking crisis in March contributed to improving consumer sentiment in mid-April, which may eventually unwind inflation to coincide with the next meeting of the Fed on May 2-3. There are also some disinflation factors that may effect this after the banking turmoil in March as major banks have tightened their borrowing conditions, while the interest rate hiking cycle also has a moderate downside effect on prices.
This has resulted in macroeconomic slowdown. Initial jobless claims rose to 239,000 in the middle of April from 228,000 at the beginning of this month. That may have a very negative impact on the Fed’s monetary policy, as strong labour market factors will no longer play a role in the solid monetary tightening policy conducted by the Fed. Retail sales also surprised markets in March as they dropped by 1% month-on-month compared to the rise of 0.2% in February. This highlighted a worsening economic situation and the negative repercussions from the banking crisis. This may have an adverse impact on the interest rate hiking process by the Fed.
Investors paradoxically rushed into Dollar-denominated assets. The U.S. Dollar index (DXY) rebounded from 100.6 points, the lowest level of 2023, and went above 101.4 points. The support at 100.5 points may become the lowest point to chart the double bottom pattern for the DXY, signaling a possible rebound of the index to 102.4-103 points. This may result in the EURUSD tumbling to 1.0860-1.0900 from 1.1000. The chance for this downside move may increase if the EURUSD dives below 1.0950.
So, the Fed has to make the first move now after the European Central Bank and the Bank of England continue with their quantitative tightening. The U.S. monetary watchdog may not find itself in a tricky situation as rising inflation dictates rises in interest rates, while economic deterioration and a possible recession are against it. Nonetheless, markets bet the Fed will raise its interest rates by 0.25 percentage points to 5.25%. This move would hardly impress investors as it its highly anticipated. Investors will scrutiny comments by the regulator in order to find any forward guidance to the further directions of its monetary policy. If the Fed decides to leave its interest rates unchanged, it may be considered as a hint that a recession may hit the stage in the second half of 2023, and may also indicate a possible decrease of interest rates by the end of 2023.
The Fed has its primary mandate to tame inflation, forcing it to keep interest rates high throughout 2023, which has been constantly reiterated by its officials. Thus, the weakening of the Dollar might not be that pinpointed as investors anticipated during the recent months.
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