U.S. Inflation Cools, Sparking Dollar Slump and Fed Rate Cut Bets

Samantha Miller

The U.S. dollar dropped sharply against major currencies overnight after consumer price data showed inflation slowing more than expected in October, leading investors to scale back bets on Federal Reserve interest rate hikes.

The dollar index, which measures the greenback against a basket of six major peers, fell 1.5% to 104.13 in Asian trading on Wednesday. That’s just off Tuesday’s two-month low of 103.98. The selloff drove a rally in currencies like the euro and British pound to their highest levels since August and September, respectively.

Annual Consumer Price Inflation Slows Sharply

The wild market moves followed data showing the U.S. consumer price index was unchanged in October versus expectations of a 0.5% increase. More importantly, the annual rise in core CPI, which excludes volatile food and energy prices, slowed to 3.2% from 3.7% in September.

Economists had forecast core inflation would accelerate to 4.1% annually. October’s 3.2% increase was the smallest 12-month gain since December 2020 and could mark the peak in inflation pressures.

The cooling inflation dented bets that the Fed will continue its ultra-hawkish stance on interest rates much longer. Markets are now pricing in a lower peak for the Fed’s benchmark rate, which currently sits in a 3.75%-4% target range.

Traders Scaled Back Fed Rate Hike Bets

Specifically, futures trading suggests about a 50% chance that the Fed will slow its rate hike pace to 25 basis points at its December 13-14 policy meeting. Just a day earlier, a 50 basis point hike was seen as fully priced in.

Markets have also pared back expectations that the Fed funds rate will rise above 5% next year. Rate cut bets for as early as May 2023 have now increased to around 50%.

The sharp repricing lifted rate-sensitive assets like government bonds. Yields on the policy-sensitive 2-year U.S. Treasury note tumbled 33 basis points overnight to 4.357%, its biggest daily decline since 2008.

Meanwhile, the 10-year yield dropped 20 basis points to 3.819%. Falling Treasury yields reduce the relative appeal of holding greenbacks.

Dollar Reaction Larger Than Inflation Surprise

While inflation is heading in the right direction, the markets’ dovish reaction was still too extreme, some analysts say. October’s core CPI rise did miss forecasts, but only by 0.9 percentage points.

“It makes sense for the markets to price out further Fed hikes at the margins, but to practically price them out entirely and double down on expectations for cuts next year is very bold,” said Kyle Rodda, market analyst at IG Group.

The latest inflation data provides some hope that price pressures are finally easing, meaning smaller Fed rate hikes could be appropriate. However, policymakers have stressed the need to keep rates elevated for some time to ensure inflation continues improving.

“The battle is far from won,” Fed Vice Chair Lael Brainard said recently, noting policy will need to be restrictive “for some time.”

Euro, Sterling Rally on Dollar Weakness

With the dollar on its back foot, the euro and British pound were among the major beneficiaries. The shared currency jumped 1.6% to an over two-month peak of $1.0873 on Tuesday. Sterling also surged 1.6% to $1.2484, around its highest since late September.

The Japanese yen staged some relief from its brutal selloff this year, which has seen the currency sink 21% against the dollar due to Japan’s ultra-loose monetary policy. The yen bounced from Monday’s fresh 24-year low of 151.94 as the greenback pulled back.

But those gains seemed fleeting, with dollar-yen last changing hands near 150.54. Some analysts say the yen remains vulnerable to further depreciation on wide policy divergence with the Fed.

The usual haven Swiss franc also advanced 1% overnight to around 0.9424 per dollar. The Swiss National Bank maintains the lowest policy rate globally at -0.75%, but may be forced to abandon its interventionist stance if the franc keeps appreciating.

Aussie Drops Despite Bumper Pay Rises

The commodity-linked Australian dollar headed in the other direction, edging down 0.2% to $0.64925 versus the greenback.

That’s despite data showing private sector wages in Australia spiked 3.1% in the third quarter, the fastest pace on record. Accelerating wage growth adds to arguments that the country’s central bank may have to keep raising interest rates to cool inflation.

The Aussie’s weakness indicates traders are more focused on China growth risks over local factors for now. Lockdowns are spreading in major Chinese cities again to curb new COVID-19 outbreaks, which will hamper Australian exports.

Oil Prices Decline on Demand Concerns

In the commodities sector, oil prices fell nearly 3% amid worries over softening demand from top importer China. U.S. crude futures slumped 2.7% to $85.60 per barrel, while Brent crude dropped 2.8% to $93.14.

Despite the latest leg lower, oil prices have still rallied about 30% from September lows on expectations of tighter supplies with the EU’s Russian crude oil ban kicking in next month.

Gold prices rose 0.7% to $1,783 per ounce as lower Treasury yields boosted the non-interest-bearing metal’s appeal.

Other safe-haven assets like the Swiss franc and Japanese yen also benefited from some investor caution. Markets remain concerned over whether central banks can tame inflation without triggering recessions globally.

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Samantha Miller is a business and finance journalist with over 10 years of experience covering the latest news and trends shaping the corporate landscape. She began her career at The Wall Street Journal, where she reported on major companies and industry developments. Now, Samantha serve as a senior business writer for Modernagebank.com, profiling influential executives and providing in-depth analysis on business and financial topics.
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