EUR/USD falls as hot US inflation data boosts Fed higher-for-longer expectations
- EUR/USD falls as hotter-than-expected US inflation data boosts the US Dollar and Treasury yields.
- Traders increase bets that the Federal Reserve could keep interest rates higher for longer.
- Rising energy costs fuel ECB tightening expectations, though growth concerns continue to weigh on the Euro.
The Euro (EUR) trades under pressure against the US Dollar (USD) on Tuesday as hotter-than-expected US inflation data strengthens the Greenback and pushes US Treasury yields higher. At the time of writing, EUR/USD is trading around 1.1743, down roughly 0.35% on the day.
Data released by the Bureau of Labor Statistics showed the headline Consumer Price Index (CPI) rose 0.6% MoM in April after increasing 0.9% in March, matching market expectations. On an annual basis, inflation accelerated to 3.8% from 3.3% previously, above forecasts of 3.7%.
Meanwhile, core CPI, which excludes volatile food and energy prices, rose 0.4% MoM, up from 0.2% in March and above expectations of 0.3%. Annual core inflation climbed to 2.8% from 2.6%, also exceeding forecasts of 2.7%.
US inflation accelerated for a second consecutive month in April, largely driven by higher energy prices as Oil remained elevated amid disruptions around the Strait of Hormuz.
The stronger-than-expected inflation data, combined with last week’s upbeat Nonfarm Payrolls (NFP) report, reinforced expectations that the Federal Reserve (Fed) could keep interest rates higher for longer.
According to the CME FedWatch Tool, traders currently expect the Fed to keep interest rates unchanged in the coming months, while also increasing bets on a possible rate hike later this year. The probability of a rate hike at the September meeting currently stands near 13.5%, rising to around 32% for the December meeting.
Rising hawkish Fed expectations and ongoing uncertainty surrounding US-Iran negotiations are helping the US Dollar rebound from recent lows. The US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, is trading around 98.37, up roughly 0.35% on the day.
In the Eurozone, traders are pricing in at least two rate hikes from the European Central Bank (ECB) this year as rising energy prices continue to fuel inflation risks. However, the Eurozone’s heavy exposure to higher energy costs is also fueling concerns about slower economic growth, which could limit the ECB’s ability to tighten policy aggressively.
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.
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