Forex: A soft PPI doesn’t necessarily predict a tame CPI today

Yesterday’s subdued Producer Price Index (PPI) might have momentarily softened the dollar, but today’s Consumer Price Index (CPI) looms large, poised to bolster the greenback potentially. We’re bracing for a 0.3% monthly climb in core CPI, which could solidify the dollar’s resurgence. While the core PPI’s flat performance gives a glimpse into December’s core Personal Consumption Expenditures (PCE) — the Federal Reserve’s preferred inflation barometer — it doesn’t necessarily predict a tame CPI today.

On the strategic front, rumblings from Trump’s economic circle hint at a tactical rollout of tariffs, escalating by 2-5% monthly. This incremental approach is crafted to enhance Trump's negotiating edge and soften the inflationary blow, contrasting sharply with the prospect of sudden, steep tariff hikes. This maneuver is paralleled by whispers of an imminent legislative blitz on migration, energy, and tax cuts by April, signalling a pivot towards aggressive domestic policy shifts right out of the gate.

Despite these dynamics, dialling back on long-dollar bets might be premature. The market has baked in a half dose of U.S. protectionism, though not an all-at-once tariff slam. But today's potentially fiery CPI readout could stoke fresh inflation jitters and unsettle markets before tariff impacts even hit the radar.

In currency corridors, the EUR/USD has dipped under 1.03 at the London open, with the spectre of falling further, dependent on today’s CPI stirring a notable US-EU interest rate differential. Such a scenario would necessitate the dollar flexing its muscles to dive below 1.02.

The Euro saw a flicker of optimism from France as Prime Minister Francois Bayrou graced the parliamentary podium, delivering a crucial policy speech aimed at breaking the legislative deadlock around the 2025 budget. His remarks ignited cautious optimism among investors, which was subtly mirrored in the narrowing OAT/Bund spread, indicating a relaxation of concerns over France's medium-term fiscal health. However, this fiscal reassurance is overshadowed by larger forces at play—particularly the looming spectre of US tariffs and the broader geopolitical risks that continue to stir significant market uncertainty.

Over in China, the yuan’s trajectory is delicately poised. Beijing is steering a cautious course, wary of reigniting the massive capital outflows of yesteryears. Recent policy fixing tweaks and liquidity maneuvers are Beijing’s bold steps to stabilize the yuan despite economic signals pointing to potential depreciation. As bond yields diverge dramatically between the U.S. and China and trade tensions simmer, Beijing might gradually allow the yuan to decline. Also, traders expect they will shy away from drastic devaluations that could mirror the tumultuous aftermath of 2015’s devaluation debacle.

Thus, as the world watches, Beijing remains vigilant, juggling trade pressures and domestic economic trials without triggering a capital exodus — a high-stakes balancing act in the face of escalating global trade tensions and internal economic strains.

The Bank of Japan is signalling stronger hints toward a January rate hike, ramping up market expectations significantly. Recently, Deputy Governor Himino subtly opened the door to this possibility, and Governor Ueda, in a spontaneously scheduled speech at the Regional Banks Association of Japan, reinforced this stance. He didn't outright promise a hike but stressed the ongoing rate discussions and robust wage growth data, significantly influencing market sentiment. With the probability of a 25 basis point adjustment now soaring to about 75%, it's clear the BoJ is deftly steering expectations toward tightening monetary policy soon. Hence, we could soon see a move into the mid to low 156s so long as US yields remain subdued.