The dollar reversed from its six week low against the euro Tuesday as traders were encouraged to book profits when the highest U.S. core inflation rate in eighteen months solidified expectations for a rate increase at tomorrow’s Federal Reserve meeting.
The euro had already fallen about half a figure from its European high of 1.1061 by the 8:30 am (New York) release of November’s price data that showed the core consumer price index rose 2.0 percent on the year. It was the largest annual gain since May 2014 and only the third month at the Fed's 2.0 percent target in the last three years. After the release the euro lost ground steadily, reaching the day's low of 1.0903 just after the London close at noon. It partially rebounded in the afternoon to close at 1.0930.
It is almost universally expected that the Federal Open Market Committee (FOMC), the central bank’s monetary policy arm, will vote to raise the Fed Funds rate tomorrow for the first time since June 2006. That hike nine years ago to 5.25 percent was the last in a string that had begun two years before in June 2004, starting from 1.00 percent and put an end to what had been at that point the lowest Fed Funds rate in history.
Today’s price data supports what the Fed has been saying for more than a year. Inflation will return once the effect of the collapse in energy price abates.
Though the Fed’s preferred measure of inflation, the core Personal Consumption Expenditure price index, was just 1.3 percent annually in October and is expected to be the same in November, today's CPI was sufficient to prompt the dollar rally.
The euro strength over the past weeks has largely stemmed from market disappointment in the ECB policy announcement last month. The central bank had been expected to increase its bond purchases from 60 billion euro per month, led by President Mario’s Draghi's assertions that the European economy badly needed further economic stimulus.
The combination of an ECB increasing monetary accommodation and a Fed setting to raise rates had driven the dollar to its best level against the euro since March this month and its second best in almost 15 years.
Though the Fed is projected to increase the Fed funds rate by 0.25 percent tomorrow, it is also expected to downplay the course of future increases, instead opting for a prolonged course of data sensitivity and observation.
The Treasury interest rate curve has flattened in recent weeks with the 2-year Treasury closing at 0.9639 percent today, its highest since May 2010, while the 10-year closed at 2.2658 percent, just over half its average rate in the first quarter of 2010.
There are more than enough global economic and financial concerns to keep Fed policy defensive, even if the governors are willing to surrender the zero bound.
The recent fall in high yield bonds, the devaluing Chinese Yuan, which may indicate deeper problems in the mainland’s economy than are admitted by Beijing, the lack of growth in Europe and the apparent inability of the continents’ governments or the ECB to promote a healthy recovery, the turmoil in the Middle East and the collapse of commodity prices, any of which or in combination could seriously impact growth in the United States and around the world, will likely keep the Fed from raising rates in any sustained and programmatic fashion for many months if not years.
Chief Market Strategist
WorldWideMarkets Online Trading