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All week, investors had been eagerly waiting for Thursday’s CPI report to inject much-needed volatility into the markets. The market was positioned for a positive surprise, and as it turned out, that’s more than what they got. The December inflation report was a little hotter than expected and this caused the dollar to bounce, and equity indices fell in the immediate aftermath of the inflation report. However, by the close of play, the markets had bounced back, and the dollar was off its lows to close the session a touch lower against a basket of foreign currencies. Today’s focus is on PPI inflation data. But judging by the dollar’s response to the CPI report, the dollar bulls will have to do a lot better if they want to maintain their control over FX markets after a positive start to the year. For stock markets, the US earnings this week will kick off with JPMorgan, BofA, Citigroup, Wells Fargo all to report results shortly.
 

Why have FX markets shown subdued reaction post-CPI?

The FX market’s somewhat subdued reaction to yesterday’s stronger CPI report suggests investors were perhaps happy to take profit on their long dollar positions. They clearly still expect rate cuts will come this year, but not sure precisely when. In fact, the odds of a March rate cut remained at around 70%, according to the CME FedWatch tool. Perhaps investors expect inflation to go back down again, so they are just looking past the December inflation report, arguing that weakness in the economy should put downward pressure on prices in the months ahead. Still, the somewhat muted reaction is surprising to say the least.

The dollar’s muted reaction could also be that investors view foreign central banks as being more hawkish than the Fed. For example, the European Central Bank official Isabel Schnabel delivered a hawkish speech to counter recent dovish ECB commentary Schnabel, said that “it is too early to discuss rate cuts” and “additional data confirming the disinflationary process” will be required to move from restrictive monetary policy.

Despite the US inflation report coming in hotter, the EUR/USD managed to hold well above the 1.09 handle, but also was unable to break the 1.10 barrier. A move outside of this range should trigger follow-up technical buying/selling in that direction.
 

How strong was the US CPI and what about the PPI?

In case you missed it, CPI rose 0.3% MoM, ahead of the 0.2% expected, pushing the annual rate up to 3.4% in December from 3.1% in November. A reading of 3.2% was expected. Core CPI rose 3.9% annually versus forecasts of a 3.8% increase. We also had better-than-expected data from the jobs markets, with jobless claims coming in at 202K, down from 210K in the previous week.

Today’s inflation data is expected to show PPI increased 0.1% month-over-month in December, after a flat reading in November. Core PPI is seen rising by 0.2% on the month.
 

Dollar index technical levels to watch

Ahead of the PPI data, the Dollar Index was up a modest 0.1% after closing flat the day before, reflecting a subdued FX market response.

The bearish trend that started from October is being tested though, and the dollar sellers must step in around these levels if they want to maintain control.

Zooming out a little, the larger time frames show lower lows on the DXY chart ever since the index peaked in October at 107.35ish.  With that in mind, the important of that key resistance zone between the 102.45 to 103.00 area should not be underestimated. This is where the DXY was residing at the time of writing. This zone had acted as strong support on a couple of occasions back in August and again in November, before giving way on the back of the Fed’s last policy meeting in mid-December.

The 200-day average could be the next upside target in the event the dollar bulls regain control over this zone in the next couple of sessions.

But for as long as that 102.45 to 103.00 area holds as resistance, this should keep a bearish bias on the dollar alive.

So, watch today’s closing prices closely to determine the directional bias for the dollar heading into the week ahead.

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