The U.S. Dollar Index (DXY) continues its downward correction on Wednesday after surpassing the 110.00 level for the first time in two years, now approaching the 109.10 level, as markets await the release of the U.S. Consumer Price Index (CPI) data for December.
This current correction reflects a clear shift in market sentiment after the Producer Price Index (PPI) data came in weaker than expected, prompting traders to revise their inflation forecasts and, consequently, expectations regarding the Federal Reserve’s monetary policy in 2025.
As the inflation data is set to be released today, future movements in the dollar will largely depend on how closely these data points align with expectations or deviate from the anticipated range.
The Consumer Price Index (CPI) remains the most important event in the U.S. economic calendar this week.
The expected inflation data ranges between 0.2% and 0.5% every month, while the core reading is expected to range between 0.2% and 0.3%. This narrow range of expectations reflects uncertainty, meaning that any reading outside of this range could lead to strong market movements.
A reading below 0.2% would be a shock to the markets, driving the dollar sharply lower, while any reading above 0.3% could support the dollar and push it back onto an upward trajectory, as it would be seen as a signal of continued inflationary pressures.
However, what concerns me is that markets have become more sensitive to economic data as the inauguration of the elected president, Donald Trump, approaches. The political silence surrounding Trump’s economic plans, particularly regarding tariffs and trade policies, adds further uncertainty to the economic outlook.
The lack of clarity regarding upcoming fiscal and economic policies increases the difficulty in assessing the future direction of the U.S. economy, and it makes the markets overly dependent on short-term economic data such as the Consumer Price Index.
On the other hand, I cannot ignore the influence of U.S. Treasury yields on dollar movement. The yield on the 10-year U.S. Treasury bond has fallen significantly from its 14-month high, reaching 4.774%, compared to 4.802% at the start of the week.
In my view, this decline suggests that investors are beginning to factor in the possibility of slowing inflation, and consequently, the potential for the Federal Reserve to ease its pace of interest rate hikes or even start a rate-cutting cycle as early as 2025. Nevertheless, this scenario heavily depends on the upcoming CPI results, which will serve as a crucial test for inflation expectations.
Additionally, scheduled events today, including speeches from several regional Federal Reserve presidents, could play a supporting role in shaping market expectations. However, in my opinion, the focus will remain on the Consumer Price Index data to be released on Wednesday. Markets are eagerly awaiting this data, as it will significantly determine the dollar’s path shortly. Any signs of continued inflation decline could lead to reduced expectations of further rate hikes, putting additional pressure on the dollar.
It’s worth noting that markets expect the Federal Reserve to keep interest rates unchanged in the January meeting, with a probability of 97.3%. However, these expectations could change quickly if the CPI data comes in higher or lower than expected. In other words, any surprise in the inflation data could prompt markets to reassess the Federal Reserve’s stance on monetary policy, which would, in turn, impact the dollar’s movement.
Therefore, I believe the U.S. Dollar Index faces multiple pressures from both the economic and political sides. From an economic perspective, signs of slowing inflation could lead the Federal Reserve to ease its aggressive monetary policy. At the same time, there is political uncertainty surrounding the incoming Trump administration and its economic policies. This mix of factors makes the dollar susceptible to significant volatility in the coming period, particularly as markets continue to rely on short-term economic data to make decisions.
In the short term, I believe the Dollar Index could continue its decline if the CPI data comes in lower than expected, as this would be seen as further evidence of easing inflationary pressures.
Conversely, if the data exceeds expectations, we could see a quick rebound in the dollar, as these figures would strengthen expectations that the Federal Reserve will maintain its current monetary policy for a longer period. Therefore, I believe investors should exercise extreme caution in their trades during this period and closely monitor the upcoming economic data results.
