EURUSD Fate Hangs in Balance Ahead of CPI

Analysts expect US inflation to have remained steady in December as central banks on both sides of the Atlantic face mounting pressure to adjust monetary policy in response to economic conditions.

The Data May Not Resolve the Debate

The timing of the Fed's first interest rate cut will be a key focus as the latest inflation data is released. At its previous meeting, the  FOMC maintained it would await further economic evidence to determine when rate reductions may be necessary. Recently, markets had priced in an initial cut as early as March, supporting the year-end stock market rally. However, more recent data paints a less optimistic picture. Last week, Morgan Stanley warned the markets had been too hopeful that easing would begin in March.

Naturally, divergence remains between the market and the Fed. While the latter signalled up to three cuts in 2024, markets act as if twice that is plausible. Adding weight to the Fed's less dovish stance, Atlanta Fed President Raphael Bostic - seen as one of the more dovish members - said that he foresees just two cuts at the tail-end of the year. Following an above-forecast jobs report showing ongoing labour market tightness, the upcoming inflation figures could eliminate any hope of a March move. Consequently, markets may start to price in fewer cuts, potentially boosting the dollar. This would imply pain for the EURUSD currency pair despite markets pricing in six ECB rate cuts.

External Factors Complicate the Situation

The prospective implications could be offset by forces outside both the Fed and ECB's control. Eurozone inflation increased month-on-month in December, albeit slightly below projections. However, higher inflation ahead of potential cost pressures from supply chain issues caused by Suez Canal disruptions could keep the shared central bank on a more restrictive path than anticipated.

What to Look out For in the Numbers

Headline US annual inflation is forecasted to stay at 3.1% in December, well above the 2% target. Some relief is expected in core inflation, where monthly CPI growth may ease to 0.2% from 0.3% prior. This could help slow the annual core rate to 3.9%, which is psychologically important as it would dip just under November's 4% print. Technically, the core measure would no longer be double the target.

An inflation surprise could offset the impact of strong jobs data, weakening the dollar and allowing EURUSD to appreciate. But higher numbers may reinforce last week's narrative that markets were too optimistic over rate cuts this year, potentially causing the dollar to regain ground.

Falling Pennant in Focus

A falling pennant appears to have emerged in EURUSD, suggesting the pair may be consolidating between 1.0877 and 1.0998 before continuing lower. A downward breakout could see prices sliding towards 1.08 according to the measured-move projection if the pattern holds true to its typical behaviour. However, a higher breakout could hit resistance at 1.1063 unless 1.1009 acts as the right shoulder of a potential H&S pattern.

Source: SpreadEx

Key Takeaways

Forecasts suggest that US headline inflation will likely remain steady in December, with core inflation decreasing slightly. While markets have been pricing in potential rate cuts as early as March, analysts at Morgan Stanley warn that markets may be too optimistic. There is a divergence between what the Fed signals and what the markets expect regarding rate cuts. The upcoming inflation figures may not clarify when the Fed will cut rates but could eliminate hopes of a March rate cut, boosting the US dollar. External factors like supply chain issues could also keep the ECB on a more restrictive path, offsetting any impact from the US data. A surprise rise in inflation could reinforce the view that markets were too optimistic on the timing of potential rate cuts this year.