Euro-Dollar On Target for 1.04 Following U.S. Inflation Print

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The Euro to Dollar exchange rate is on course to hit the 1.04 mark, according to analysis that follows the USD's jump in the wake of U.S. inflation data for January.

The Euro fell against the Dollar after U.S. inflation rose 3.1% year-on-year in January, beating expectations for 2.9%. Importantly, analysts noted that a whole range of goods and services in the inflation basket showed deflationary pressures in the U.S. were fading.

"Obviously not good news for the Fed and the market pricing of a March cut, let alone a cut before summer took a big hit," says Kristoffer Kjær Lomholt, Director of FX and Rates Strategy at Danske Bank.

Above: Euro-Dollar at daily intervals. Track GBP with your own custom rate alerts. Set Up Here

The U.S. inflation reading follows a strong jobs report earlier in February and explicit pushback from Federal Reserve Chair Jerome Powell against expecting any imminent cut.

"The rate cuts are getting priced out/rolled further out the curve, with cuts before summer looking increasingly unlikely," says Lomholt.

He notes there are now approximately 90 basis points worth of rate cuts priced for the Fed over the course of the year, in sharp contrast to the approximate 150bp worth of cuts priced at the beginning of January.

This downward shift in rate expectations boosts the dollar and pushes the euro-dollar exchange rate towards Danske Bank's 1.05 target.

As can be seen below, the Scandinavian lender and investment bank does not agree with a consensus that sees a steady rise in the Euro-Dollar during 2024, saying valuation is a headwind and thus acts as a source of gravity for the exchange rate.

Analysis from Ulrich Leuchtmann, Head of FX and Commodity Research at Commerzbank, also reveals the Dollar's strength is due to the fact that longer-term Fed rate expectations have also started to move.

"The market is no longer pricing in faster rate cuts than the FOMC itself predicted in the form of the "dots" in December. For the first time, the market is swallowing the Fed's story: that rate cuts will be gradual," he explains, presenting the below chart:

Commerzbank's economists caution that the January inflation report should be treated with caution due to statistical rebalancing that can create some noise.

"The figures probably do little to change the fundamental decline in inflationary pressure. After all, the January figures in particular have often been out of line in the past," says Christoph Balz, Senior Economist at Commerzbank.

Leuchtmann points out we get another PCE inflation reading as well as another headline inflation report covering the February period before the Fed meets again.

"Therefore, it is my duty to point out to you that the current strength of the USD should also be treated with caution," says Leuchtmann.