Inflation in
the United States has been in the
downward trajectory for past several months after hitting its multi-decade peak
of 9.1% in June. It fell to 6.4% in January, but it is still
uncomfortably high.
The US Federal Reserve took aggressive measures during 2022 and raised its interest rates from levels near zero to the current 4.50% / 4.75% range, in the cycle of sharp monetary policy tightening, not seen in decades.
The US policymakers described the strong rise in interest rates as the best weapon against high inflation, being the first to introduce radical measures which were eventually followed by other major central banks. However, the action did not yield the desired results so far, suggesting that the battle against rising prices is still far from the end.
The
policymakers remain concerned,
expressing their worries that stubbornly high inflation may become
entrenched, (a number of economists kept warning about such a scenario) which would make
the task of the US central bank in curbing inflation, much more difficult and
long-lasting.
Although the
Fed eased the pace of hiking rates from a series of four consecutive 75-basis points hikes to 50 basis points in December and 25
basis points in January, with expectations for another hike of the same size in
March, the tone of the minutes of Fed’s last policy meeting was more hawkish
than expected, signaling that the central bank has left the door open for
extension of the tightening
phase beyond initially estimated time and a possible return to the more aggressive mode.
In addition to
threats from fresh signals that inflation is likely going to stay elevated for an extended period, the US
central bank has revised its expectations for the
terminal rate (the point when policymakers expect to end rate
hikes) from the initial 5.1% to slightly
above 5.4%, which is expected to be reached in the third quarter of 2023.
The central
bank also worries that the recent slowdown in the pace of hiking rates
was too fast and too early, which could result in a
fresh rise of inflation, as seen
during the crisis in 1970’s and early 1980’s.
On the other
hand, recent robust US economic data and a tight labor market,
suggest that the Fed has the space
to raise interest rates further without causing significant negative impact on
economic growth and ease fears that the economy would slide into recession.
Adding to the fresh hawkish rhetoric were comments from the major US banks, such as Bank of America, Citigroup and Goldman Sachs, all of which warned that current signs of disinflation are likely to be transitory, before inflationary pressures start to rise again in the coming months.
The latest US
personal consumer expenditures (PCE) and consumer spending data showed that
inflation started to rise again in January. The PCE,
Fed’s preferred gauge for inflation, jumped above the previous month’s value
and well above expectations while consumer spending surged, contributing to the view that
the economy remains resilient despite a slowdown in the last quarter of 2022
and supporting the Fed’s
intentions to extend its policy tightening cycle.
The US dollar rose around 2.5% against the basket of major world currencies during the past four weeks, riding on the back of the wave of fresh signals that the US central bank would extend its rate hike campaign and possibly accelerate the process again.
Fresh signals that
the Fed might be turning from easing the pace of tightening to the faster lane,
revived optimism and boosted demand
for the US currency, pushing the dollar index price to monthly high.
The price action in February marks the first monthly gain after a steep fall in the past four months, generating an initial sign of reversal pattern formation on the monthly chart, adding to hopes that the dollar would rise further on improved environment and signal that the four-month correction of the larger uptrend since early 2021, might be over.
However, solid US economic data may contribute to fresh risk appetite, which would be negative for the US currency.
