Economic data watch: can inflation data save the dollar?

This week all eyes will be on US inflation data. On Wednesday US inflation will be released at 1330 BST, and inflation is expected to moderate further. In the current environment, all eyes will be on how fast the decline is and whether the Fed’s fight against inflation is winning, or if they are starting to lose effectiveness. Alongside UK GDP data, Chinese lending data and the start of US corporate earnings season to ensure there are plenty of fundamental factors that will drive markets as we move through April.

US inflation is expected to moderate further in March, with headline inflation expected to fall to 5.2% annual rate, compared with 6% in February. While headline inflation is important, it is the core rate of price growth that we are watching, largely because this is the rate of price growth that the Federal Reserve uses to determine monetary policy. Core CPI is expected to rise to 5.6% from 5.5% in February on an annual basis, however, on a monthly basis core CPI is expected to rise by 0.4%, down a notch from a 0.5% increase in February. Thus, we are expected to get confirmation that we are at an interesting juncture for US inflation, with the headline rate expected to fall below the core rate of inflation, for the first time since inflation has been spiking higher in recent years. This matters for future monetary policy. While last year was all about headline inflation, in 2023 the focus is shifting to core inflation, and how sticky price growth will be. Within the core inflation reading, we will be looking at the impact of shelter costs, which have remained stubbornly high. If shelter costs continue to rise, then it will ultimately make it more like that the Federal Reserve will continue to hike interest rates at the May meeting and beyond to bring core price growth closer to the Fed’s target rate of 2%.

There is a strong argument that shelter costs will only fall when unemployment in the US rises. Last week’s US jobs report showed that hiring had slowed for the second month in a row in March. NFPs increased by 236k, down from the 311k recorded in February. There were some interesting observations from last month’s jobs report: 1, that jobs growth around 230k is seen as sustainable with the Fed’s 2% inflation target, 2, that the collapse of SVB bank and Credit Suisse came towards the end of the survey period, and thus the impact of the rising financial stress may not be seen in the jobs report until April or beyond; and 3, wage growth is close to a 2-year low, however, it is still well above the Fed’s 2% target rate for inflation, at 4.2%. Monthly jobs growth was 0.3% in March, up from 0.2% in March. This is still at an uncomfortably high level, even if it is moderating. The unemployment rate fell further to 3.5%, however, if the economy continues to produce jobs at a rate of 200k + per month, then we would expect the unemployment rate to remain historically low. It could take a long time for the unemployment rate to return to more normal levels around the 5% level.

In terms of market reaction, this holiday-shortened week has seen little movement in the FX space, although the pound is down from its recent 10-month high and is trading at its lowest level since early April. Although both GBP/USD and EUR/USD maintain their bullish stance, momentum could start to fade, especially if inflation data gives the dollar a boost. As we have mentioned, fundamental data is driving the FX space right now. After a slowdown in NFP growth, the market will be looking to see if inflation is also slowing in the US, and if that will give the Fed pause for thought when it meets next month. The market is currently pricing in a more than 71% chance of a 25bp rate hike to 5-5.25%, this could be confirmed or dismissed depending on the outcome of the March inflation report in the US.

EUR/USD will also be in focus this week. If US inflation is confirmed to be 5.2% then this will be significantly lower than inflation in the Eurozone. German harmonised EU CPI is also released for March this week, and it is expected to be 7.8%. Thus, the pressure could still be on the ECB as it starts moderating for the Federal Reserve. If this happens, then expect it to be played out in the FX market, with a break of the recent $1.0960 high a possibility. It is worth noting that any negative surprises from earnings season in the US this week could see a risk-off tone to financial markets that would be dollar positive. Momentum in the dollar downtrend does appear to be slowing, so make sure that you remain nimble if trading FX in the coming days.