Markets fluctuated within a narrow range during the first two trading days of the week as traders avoided making sharp bets while awaiting critical U.S. inflation data set to be released tonight, which could offer further clues on the Federal Reserve's policy path.
Following the release of surprising employment data on Friday, major Wall Street banks reduced their projections for rate cuts by the Fed this year. A robust labor market would provide the Fed with room to adjust interest rates cautiously if President-elect Donald Trump's policies raise inflation as anticipated after he takes office next week.
Meanwhile, expectations of a more cautious Fed have bolstered projections for the U.S. dollar. Goldman Sachs strategists revised their dollar forecasts upward for the second time in two months and now anticipate a 5% increase over the next 12 months.
Deutsche Bank strategists, on the other hand, foresee the euro falling below parity and fluctuating in a range of 0.95 to 1.05 against the dollar this year. If the Fed adopts a hawkish stance this year, the widening interest rate differential with its peers is likely to put other currencies under pressure against the dollar.
According to data compiled by Bloomberg, speculative investors, including hedge funds and asset managers, have raised their bullish bets on the dollar to $33.7 billion, the highest level since 2019. This surge reflects concerns sparked by Trump, even though the U.S. dollar is historically expensive at current levels.
Trump's tariff concerns are increasing uncertainty about global growth and inflation. A report published on Tuesday, based on a survey of 1,400 experts from 125 countries, revealed expectations for global inflation to remain elevated through 2028. Forecasts for global inflation in 2025 stand at 3.9%, with an average inflation rate of 3.5% projected over the next three years.
Additionally, two different surveys published last week indicated that American consumers expect higher inflation in the coming years than previously anticipated.
According to results from the New York Fed's Consumer Expectations Survey released on Monday, expected inflation three years from now rose to 3% from the previous month's 2.6%. Expected inflation for this year remained steady at 3%. Besides, The University of Michigan's survey results, published Friday, showed a half-point increase in expected inflation for this year, rising to 3.3%.
On the other hand, recent reports suggest that Trump's new economic team is discussing a gradual approach to tariffs to help prevent sudden inflation spikes and strengthen negotiation leverage. These gradual increases could range from 2% to 5% monthly. Trump had previously denied similar reports last week but has not issued any new statements on the matter.
Some economists argue that even with gradual tariff increases, U.S. inflation could rise. According to UBS AG's Arend Kapteyn, rolling tariffs could trigger successive supply shocks, leading to a much higher inflation peak.
A one-time tariff hike, unless significantly large, would likely have no spillover effects. Kapteyn also noted that the risks associated with U.S. tariffs have not yet been fully priced into financial markets.
Uncertainty about how aggressively the new president will implement tariffs is unsettling markets and triggering a flight to quality. However, markets need to wait for Trump to assume office and clarify his policies to gain a clearer outlook.
CPI Release: A Crucial Test for Inflation Projections
A report released yesterday by the U.S. Bureau of Labor Statistics revealed an unexpected decline in producer prices. The Producer Price Index (PPI) for final demand rose by 0.2% in December compared to the previous month, falling short of economists' median forecast of a 0.4% increase. However, on a year-over-year basis, the rise accelerated from 3% to 3.3%.
The core measure, which excludes food and energy, remained unchanged from November but saw an annual increase to 3.5%. These figures primarily reflected a decline in food costs, while service prices remained subdued.
The monthly producer price figures slightly eased concerns about persistent price pressures. However, traders are holding off on shaping their expectations until later today when the U.S. Consumer Price Index (CPI) for December is released.
Forecasters expect the monthly report to show robust gains for the fifth consecutive month. According to a Bloomberg survey, economists' median estimate predicts a 0.3% monthly rise in the core measure, excluding food and energy, with the annual increase holding steady at 3.3%.
Of the surveyed economists, 39 forecast a 0.3% rise in the core measure, while 32 were more conservative, expecting a 0.2% increase. Additionally, the monthly gain in overall items is projected to rise to 0.4%, with a 2.9% year-over-year increase.
In November, inflation rose amid Trump's tariff concerns, driven by a surge in demand for key goods. If today's figures show a similar increase, market expectations for the Fed's rate cut outlook could turn even more pessimistic.
Swap markets are currently pricing in only a quarter-point cut for 2025. Some economists have even started suggesting the possibility that the Fed might not implement any cuts this year, depending on the trajectory of inflation.
Expectations surrounding inflation and the Fed could shift throughout the year based on Trump's policies. However, with just days until Trump's inauguration, a high inflation reading today could amplify these expectations, potentially strengthening the dollar further. This would deepen losses for other currencies and potentially increase pressure on precious metals.