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US CPI inflation data: Why does it matter?

Traders work on the floor of the Dow Industrial Average at the New York Stock Exchange
Traders work on the floor of the Dow Industrial Average at the New York Stock Exchange Copyright BRYAN R. SMITH/AFP
Copyright BRYAN R. SMITH/AFP
By Indrabati Lahiri
Published on
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US inflation in October fell below market expectations causing stocks and bonds to rally whilst the dollar and US Treasury yields weakened.

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The US year-on-year inflation print for October was released on Tuesday afternoon, coming in at 3.2%. This was below analyst expectations of 3.3%, as well as September’s 3.7%. Meanwhile, year-on-year core inflation was 4%, a slight decline from September’s 4.1%.

Why did US inflation fall?

The inflation decline was mostly supported by falling vehicle, shelter and airfare costs and will be closely watched by the US Federal Reserve as it considers its next monetary policy decision. 

Investors hope that the central bank may choose to end its tightening cycle earlier than expected. According to the CME Group’s FedWatch tool, markets are betting on a 94.8% chance that the Fed will continue to hold rates steady during its December meeting.

How did the markets react?

Stocks and bonds rallied following the release, with the S&P 500 index jumping 1.86% to trade at $4,492.5 on Tuesday afternoon and the Nasdaq 100 surged 1.92% to clock in at $15,780.5, while the Dow Jones Industrial Average index rose 1.32% to $34,790 on Tuesday afternoon.

Why US inflation matters

US inflation data has a huge impact on foreign currency rates, as well as the price of debt, imports and exports. Following the release of the October inflation report, the US dollar plunged, as investors all but assume that the Fed may be done hiking interest rates. 

This sparked a huge sell-off in the Greenback, with the biggest rejoicers being other currencies which are usually paired with the dollar. Amongst these, central European currencies such as the Czech koruna and the Polish zloty saw the largest wins.

In cases of high inflation, when the US Federal Reserve hikes interest rate, it can considerably boost the dollar. On the domestic front, it leads to higher mortgage payments as well as higher rents. It also increases the cost of borrowing for other kinds of loans, apart from mortgages.

Global economic impact

On the international front, it may increase the cost of repayments, especially for emerging market economies. This can lead to a range of defaults and propel these economies closer to chaotic situations sparked by increasing costs of key imports such as medicines, food and fuel.

Rising interest rates also bring the US economy closer to recession and slows down economic growth. This causes a decline in demand for imported goods, affecting markets as well. As the dollar strengthens, it may discourage foreign investments both in the US, as well as other countries. It also erodes away the value of other currencies which are paired with the dollar, such as the Japanese yen.

This is why, in cases of lower inflation, such as the October figure, investors are more hopeful that the Fed’s tightening cycle may end and give the economy a chance to recover growth and demand.

Will the Fed let up so easily?

However, despite increasing investor optimism, the Fed is still treading cautiously, with chair Jerome Powell warning that more may have to be done to get inflation back in line with the 2% target. As such, he has continuously warned markets that in case of unsatisfactory economic data, further hikes could definitely be back on the table.

Powell has also shown concerns about still present upside risks to inflation, such as sticky gasoline prices. The ongoing Russia-Ukraine war, as well as the recently sparked Israel-Hamas conflict are also potential risks to the global energy market, which may cause new price shocks.

However, according to the OPEC November report, the global oil market is still remaining resilient, despite sentiment waning.

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