MUFG’s Derek Halpenny notes that weaker US CPI has sharply reduced market expectations for a Federal Reserve rate hike, undermining a key source of recent US Dollar strength. He highlights Fed Chair Warsh’s firm focus on the 2% inflation mandate, the impact of Middle East tensions and higher Oil prices, and observes that EUR/USD is finding support around the 1.1400 level.

Weaker CPI undermines hike expectations

"Following Fed Governor Waller’s comment on Monday that a strong core CPI print would compel the Fed to hike in the near-term, the CPI report released yesterday had become even more important for the financial markets. The fact that the CPI print was much weaker than expected has removed in an instant a key near-term driver of US dollar strength. We never agreed with the pricing of a possible July rate hike (or indeed through the rest of the year) and the CPI print has helped remove that nearly fully from close to a 50% probability to closer to 15% now."

"Just like following his first FOMC meeting, Warsh spoke with conviction in relation to the Fed achieving its 2% inflation goal. The CPI print was not “mission accomplished” and he wasn’t going to “cherry pick” data. He added that he was “doubling down” on the Fed’s inflation goal."

"Despite the muted FX reaction, the scale of weakness in the CPI report certainly helps weaken on key pillar of support for the dollar – the prospect of a near-term hike. That can open up scope for further dollar depreciation. However, it is difficult to trade with conviction given the re-escalation in the conflict in the Middle East and the 13% surge in crude oil prices this week."

"But EUR/USD continues to struggle to sustain declines below the 1.1400 level and at the very least the CPI data reinforces the support around that level."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)