A bit of an FX roller coaster

The US CPI inflation report and the Fed meeting had a notable enough impact on markets yesterday, including in FX, albeit pulling in opposite directions. The euro and sterling gained around a cent against the dollar after May’s inflation data came in softer than expected, trading up to intra-day highs of around $1.0850 and $1.2860 respectively, but they both gave up some ground again after the Fed left interest rates unchanged and pointed to just one rate cut this year. EURUSD is trading at $1.0810 this morning, and the pound is back just below the $1.28 level at $1.2790, while EURGBP has recovered from its low of the week of around £0.8420 to trade at £0.8460.

The inflation data triggered a decline in government bond yields across the board, albeit led by the US with 2- and 10-year Treasury yields down around 15bps on the day at one stage. However the latter backed up again post the Fed meeting to close around 8-9bps lower overall. In equity markets, European stocks rallied on the back of the inflation numbers, gaining around 1.5%, while the S&P 500 added around 1%, closing at a new record high.

Yesterday’s CPI report showed the annual rate of headline and core inflation both fell for a second consecutive month in May, to 3.3% and 3.4% respectively from 3.4% and 3.6% in April. Core consumer prices rose by 0.16% last month, the smallest monthly increase by far this year, and indeed the smallest increase since August 2021.

It was so surprise at all that the Fed left interest rates unchanged yesterday. It acknowledged the past couple of better than expected inflation readings, noting that “there has been modest further progress” towards its 2% inflation target. Despite this though, it revised up its forecasts for inflation for the end of this year and next year, and accordingly indicated just one quarter-point cut in interest rates this year, down from three in its previous forecasts.

In his post meeting Q&A, Fed Chair Powell played down to some extent the new set of forecasts, including for interest rates (e.g. the projections for inflation are “conservative”, and no cut, one cut or two cuts in interest rates this year are all “plausible”), saying the Fed remains data-dependent and that more “good” inflation readings like the latest one would increase its confidence inflation is heading back sustainably to target. Post Fed, the market is pricing in c.40bps of cuts this year, slightly more than at the start of play yesterday.

There’s more inflation data due in the US today, this time producer prices, with jobless claims scheduled there as well, while we also get industrial production in the Euro area.