The release of lower-than-expected U.S. Consumer Price Index (CPI) or inflation data has significantly impacted currency markets. The U.S. Dollar weakened overnight as most currencies strengthened against it, though the Dollar managed to recover slightly. The market now awaits further developments to see if the lower CPI will continue to exert downward pressure on the Dollar or if it will regain its earlier levels.
Treasury Yields and Inflation Data
U.S. Treasury yields have declined following the inflation data release. The Headline CPI for June came in at 2.98% year-over-year, down from 3.25% in May. The Core CPI, which excludes volatile food and energy prices, was at 3.28% in June, down from 3.41% in May. These figures have brought Treasury yields closer to their support levels, with a failure to bounce back potentially triggering an extended decline. Meanwhile, German yields saw a sharp decline but remain supported to limit further downside.
Gold Prices Surge
Gold prices saw a sharp rise yesterday, fueled by the release of lower-than-expected U.S. CPI data. This move highlights investor sentiment turning towards safe-haven assets amid lower inflation rates and weaker Dollar strength.
Hits and Misses
The overall consumer price index unexpectedly dipped by 0.1% on the month versus forecasts of a 0.1% increase. The 12-month CPI inflation rate fell to 3% from 3.3% in May. Core CPI rose just 0.1% compared to May levels, cooler than the anticipated 0.2%.
The 12-month core CPI inflation rate, at 3.3%, fell from May’s 3.4% and undershot the expected 3.5%. It’s noteworthy that the core CPI rose only 0.06% in June on an unrounded basis, the smallest increase since January 2021.
Goods prices fell 0.1% on the month and were down 1.8% from a year ago. Prices for new vehicles decreased by 0.2% from May and 0.9% year-over-year, marking the biggest annual decline since May 2018. Core services prices rose just 0.1%, the lowest since August 2021, after a 0.2% increase in May.
Overall shelter prices increased by 0.2%, despite a 2.5% decline in hotel and motel rates. Increases in primary rent and owner’s equivalent rent were also the smallest since August 2021. Transportation services prices fell 0.5% for the second consecutive month, driven by a 5% drop in airline fares.
Summary Table
| Metric | June 2024 | May 2024 | Forecast | Notes |
|---|---|---|---|---|
| Overall CPI (Monthly Change) | -0.1% | +0.1% | +0.1% | Unexpected monthly dip |
| 12-Month CPI Inflation Rate | 3.0% | 3.3% | Fell from 3.3% in May | |
| Core CPI (Monthly Change) | +0.1% | +0.2% | +0.2% | Cooler than anticipated |
| 12-Month Core CPI Inflation Rate | 3.3% | 3.4% | 3.5% | Undershot expectations |
| Core CPI (Unrounded Monthly Change) | +0.06% | Smallest increase since January 2021 | ||
| Goods Prices (Monthly Change) | -0.1% | |||
| Goods Prices (Annual Change) | -1.8% | |||
| New Vehicle Prices (Monthly Change) | -0.2% | |||
| New Vehicle Prices (Annual Change) | -0.9% | Biggest year-over-year decline since May 2018 | ||
| Core Services Prices (Monthly Change) | +0.1% | +0.2% | Lowest since August 2021 | |
| Overall Shelter Prices (Monthly Change) | +0.2% | Despite a 2.5% decline in hotel and motel rates | ||
| Primary Rent and Owner’s Equivalent Rent | +0.3% | Smallest increases since August 2021 | ||
| Transportation Services Prices (Monthly) | -0.5% | -0.5% | Second consecutive month of decline, driven by a 5% drop in airline fares |
Federal Reserve and Market Expectations
The probability of the Federal Reserve leaving the policy rate unchanged in September dropped below 10% following the inflation data release, causing the U.S. Dollar to weaken against major rivals. Traders are closely watching the upcoming Producer Price Index (PPI) data. Even if the PPI initially weighs on the Dollar, investors may book profits ahead of the weekend, potentially triggering a short-lived decline in GBP/USD.
Currency Movements
Currently, GBP/USD is extending its winning streak, refreshing 2024 highs above 1.2950 during the European session on Friday. The pair gains traction as the U.S. Dollar remains pressured ahead of the U.S. PPI and Consumer Sentiment data releases. Similarly, EUR/USD extends weekly gains towards 1.0900 in European trading, supported by sustained Dollar weakness following softer-than-expected CPI data and the USD/JPY sell-off.
Upcoming Economic Indicators
In the second half of the day, the U.S. economic docket will feature the Producer Price Index (PPI) data for June. On a monthly basis, PPI is forecasted to rise by 0.1%. A negative reading could add more pressure on the Dollar and help EUR/USD push higher. Conversely, a stronger-than-expected increase could help the Dollar maintain resilience.
Why Does Inflation Weaken The Dollar
Lower Interest Rates
When inflation drops significantly, central banks like the Federal Reserve often respond by lowering interest rates to stimulate economic activity. For instance, let’s say the U.S. inflation falls to 1% from an expected 2%. In response, the Federal Reserve might cut interest rates from 3% to 1.5%. Lower interest rates make U.S. financial assets less attractive because they offer lower returns compared to other countries.
Consequently, investors seeking higher yields might shift their investments to currencies like the British Pound (GBP) where interest rates are higher, leading to an appreciation of GBP/USD. For example, if the Bank of England maintains a higher interest rate, GBP/USD could rise as investors sell USD in favor of GBP, causing the dollar to weaken.
Economic Growth Perceptions
Lower inflation can also signal weakening consumer demand and potential economic stagnation. If the U.S. inflation rate decreases to 1%, it may indicate that the economy is slowing down. Investors might perceive this as a negative indicator for future economic growth and thus move their investments to regions with stronger economic prospects like the Eurozone.
If the Eurozone is experiencing robust economic growth, investors might prefer holding Euros over U.S. Dollars. This capital shift can lead to an appreciation of EUR/USD, further weakening the dollar as funds flow out of the U.S. and into European markets.
Market Expectations
Market expectations on monetary policy changes play a significant role in currency valuation. When inflation is low, investors might anticipate that the Federal Reserve will implement quantitative easing (QE) or other accommodative policies to boost inflation and economic activity. For example, if investors expect the Fed to announce QE, they might start selling U.S. Dollars in anticipation of increased money supply, which typically weakens the currency.
This expectation can lead to a decline in the value of the USD against major currencies like the Euro (EUR/USD) and also impact commodities like gold. Gold prices often rise when the dollar weakens because gold is priced in dollars, making it cheaper for foreign investors. For instance, following a Fed announcement of QE due to low inflation, the price of gold could surge as demand increases.
Relative Inflation Rates
The relative inflation rates between countries also influence currency values. Suppose the U.S. has a 1% inflation rate while the Eurozone maintains a 2% inflation rate. The lower inflation rate in the U.S. might prompt the Federal Reserve to keep interest rates low, making the USD less attractive compared to the Euro. Investors might then prefer holding Euros, anticipating better returns due to relatively higher interest rates in the Eurozone. This shift in investment could lead to an appreciation of EUR/USD, resulting in a weaker dollar.
Trade Balance and Competitive Pricing
While lower inflation can make U.S. goods more competitive internationally by reducing their prices, it might also reflect reduced domestic demand, indicating potential economic weaknesses. If investors perceive the U.S. economy as struggling due to low inflation, they might shift their investments to more stable economies, like Switzerland, further weakening the USD. Instead of holding on to dollars, investors might buy stable assets like gold, which traditionally acts as a safe haven during economic uncertainty. As a result, gold prices can increase significantly when the dollar weakens due to low inflation.
Lower inflation affects the U.S. Dollar through various mechanisms, including lower interest rates, altered economic growth perceptions, market expectations of monetary policy changes, relative inflation rates, and trade balance impacts. These factors collectively contribute to weakening the dollar, as evidenced by movements in currency pairs like GBP/USD and EUR/USD, and the rising prices of commodities like gold.
To sum up, let’s visualize how these factors interconnect:
- Low Inflation ↓
- Lower Interest Rates → Lower Returns
- Weak Economic Signals → Reduced Confidence
- Market Expects QE → Increased Money Supply
- Relative Inflation Rates → Attractive Alternatives
- Capital Outflows → Weaker Dollar
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