Upside surprise in US CPI to support the dollar in the months ahead

The much-awaited January inflation report was released today in the United States. The prices of goods and services increased by 0.5% MoM in January, as forecast.

However, the yearly CPI came out hotter at 6.4%, when the market expected a decline to 6.2%. Nevertheless, the print for January is lower than the one for December (6.5%), so a disinflationary path can be seen.

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The big question is – what does it change for the Fed and the funds rate?

The near-term outlook for the Fed is that it will increase the funds rate twice, each time by 25bp. Given the uncomfortably high core measure for inflation, it will probably do so.

What markets wanted, and especially stock market investors, was for inflation to come down faster. On such an outcome, the bets would have been higher that the Fed will not deliver another two rate increases.

But as is the case, the January inflation report supports further rate hikes. Thus, it supports the US dollar.

Details of the US January CPI report

Food and energy prices rose by 0.5%, respectively 2%. Also, apparel prices climbed by another 0.8%.

On the other hand, used car prices declined by -1.9%. All in all, the disinflationary road looks bumpy.

How did markets react?

The currency market is the most sensitive to inflation data because changes in the actual number vs. the forecast influence future interest rate decisions.

The initial reaction was mixed – because the report was mixed. For example, one may argue that the disinflationary process continues, but another may say that yearly inflation came out higher than expected.

As such, any market movement at this point should be taken with a grain of salt. But the overall inflation report should support the dollar moving forward.

To sum up, inflation is coming down, but not at the pace the Fed will like to see. Therefore, the odds that the Fed will be holding the funds rate above 5% this year increase, and so the dollar has more room to rally.