The U.S. Dollar Index (DX) depreciated 0.6% on Wednesday, April 12, following the release of the March CPI report and the March 21-22 FOMC policy meeting minutes. Monthly inflation rose less than expected at 0.1% last month compared to 0.2% being the consensus forecast. Moreover, on an annual basis, CPI came in at 5.0%, an entire percentage point below the 6.0% record in February. That represented the slowest YoY increase in prices since May of 2021. However, Core CPI, which does not include energy and food prices, rose to 5.6% annually, which was higher than the 5.5% reported previously.
Stubbornly high rent prices were seen as a critical factor pushing core CPI higher. The solid underlying inflation pressures are seen as making the Fed more likely to hike at its next meeting. However, the combination of this data with the FOMC minutes led to growing expectations that the Fed will cut rates later in the year as it is now seen projecting a mild recession.
How Did Markets React?
On Wednesday, the EUR/USD (EURUSD) poked above the 1.1000 handles, the highest since the start of February, but retraced some gains later in the session. In addition, the ECB is expected to continue to raise rates for longer than the Fed, as German inflation saw an uptick earlier on Wednesday, arriving at 7.4% yearly. Since Wednesday’s CPI and FOMC releases and as of the time of the writing, the GBP/USD (GBPUSD) gained 0.2% and rose to levels not seen since May of last year, with analysts pointing to higher inflation in the U.K. as CPI remains in double digits and higher than expectations.
On the flip side, major U.S. indices slipped following the release of the data on Wednesday. The S&P 500 (USA 500) fell 0.41%, Dow Jones (USA 30) 0.11%, and the tech-heavy Nasdaq (US-Tech 100) 0.85%. Yields on the benchmark 10-year bond also receded, sliding to 3.40%.
All in all, it seems that the key takeaway from the FOMC minutes was concern about the banking sector and that officials expected the U.S. to slip into a recession later in the year. Some officials even considered pausing rate hikes. Markets have priced in a 69% chance that the Fed will hike by 25 bps at the next meeting on May 2-3, but that has come down to 66.5% on Thursday, April 13.
Fed Hikes About to Round Off?
While the inflation figures show prices are still rising at a rate that isn't considered as comfortable for the Fed, inflation is still showing signs of deceleration. The headline figure included a 3.5% drop in energy prices, with food prices remaining generally steady and egg prices notably dropping by 11% last month. Shelter prices, which make up about a third of the weighting of the CPI, increased 0.6% in the month, the smallest gain since November 2022.
Analysts point to the likelihood of prices coming down as the economy slows while markets are gaining confidence that the next meeting will see the last hike from the Fed. The Fed has been trying to slow inflation down without causing a recession, but it appears it now believes there will be a “mild” one. On the other hand, the Atlanta Fed's data points to an annualised GDP growth rate of 2.2%, but many economists still expect a recession later in the year.
Fed Officials Considered a Pause
The minutes of the last FOMC meeting also showed that several Fed officials considered a rate pause in the wake of the banking crisis, worried that the financial stress from the failure of two regional banks, Silicon Valley and Signature banks, would push the economy into recession. However, they ultimately concluded that fighting inflation was more important. Some participants also considered a 50 bps hike would be appropriate if the banking crisis hadn't happened.
The failures of SVB and Signature banks provoked more caution among Fed officials, thus weakening their commitment to further rate hikes. The summary of projections showed that officials believe one more rate hike is needed before stopping. Assessing the potential fallout of the banking sector, Fed staff saw that the stress would induce a "mild recession" that would start later in 2023, with a recovery expected in 2024-2025. (Source:Yahoo Finance)
The dollar weakened following the release of the latest US CPI figures, as the data combined with the minutes of the last FOMC meeting suggested that the Fed would hike by a quarter of a point at the next gathering on May 2-3. Fed staff also forecast a mild recession in the latter half of the year.
While some investors remain optimistic, others are cautious as they wait for more clarity about the economy's direction and the Fed's policy plans.