US Dollar closes neutral week as markets digest US inflation data

The DXY Index recovered toward 102.40 after falling close to 102.20.
December PPIs came in lower than expected at 1.8% YoY.
The US 2-year yield fell to lows not seen since May 2023.

The US Dollar (USD), as gauged by the DXY Index, has experienced downward pressure, trading as low as 102.20 amidst weak Producer Price Index (PPI) data from December but then recovered toward 102.40. Following the readings, US bond yields are declining, while dovish bets on the Federal Reserve (Fed) intensified.

The Fed's dovish stance, based on welcoming the cooling inflation and projecting no rate hikes in 2024, has recently weakened the USD and seems to be offsetting the resilience of the US economy while other economic blocks are weakening. Despite higher CPI numbers, the market remains stubborn and expects the Fed to initiate its easing cycle sooner rather than later, and the soft PPI readings gave markets a reason to bet on a less aggressive approach.

Daily digest market movers: US Dollar pressured down by soft PPI and falling US yields

US Producer Price Index (PPI) for final demand rose by 1% on a yearly basis in December, slightly below market expectations of 1.3% and up from the revised 0.8% increase in November.
The annual core PPI, which excludes volatile food and energy prices, increased by 1.8% in December, falling below both the November reading and analysts' estimates of 2% and 1.9%, respectively. The monthly core PPI remained unchanged for the third consecutive month.
US bond yields are declining. The 2-year yield is currently at 4.13%, its lowest since May 2023, while the 5-year yield rests at 3.83% and the 10-year yield sits at 3.94%.
The CME FedWatch Tool reveals no rate hike predictions for the January meeting. Instead, March and May 2024 meeting expectations indicate increased probabilities for rate cuts despite Thursday’s hot inflation reading for the CPI.
The odds of a cut in March rose to 77%, while the odds of another one in May jumped to 70%.
As tensions rise in the Red Sea between the US and Houthis rebels, the downside is limited for the index.

Technical Analysis: DXY index buyers hold their ground, indicators still in positive territory

The daily Relative Strength Index (RSI), which is currently flat and in positive territory, indicates that buyers have halted their momentum but still maintain control in the short run. Adding to this narrative of tentative bullish strength is the Moving Average Convergence Divergence (MACD). Despite being flat, it's displaying green bars that suggest buying pressure is maintaining a steady pace.

Meanwhile, when examining the Simple Moving Averages (SMAs) in the short-term, the buyer's strength is still in play, given that the pair is trading above the 20-day SMA. Nevertheless, trading under both the 100 and 200-day SMAs, a more significant time frame, indicates sellers hold the upper hand in the middle and long-term perspective.

Support levels: 102.15, 102.00 (20-day SMA), 101.80.
Resistance levels: 102.50, 102.70, 102.80.

Central banks FAQs

What does a central bank do?

Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.

What does a central bank do when inflation undershoots or overshoots its projected target?

A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.

Who decides on monetary policy and interest rates?

A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.

Is there a president or head of a central bank?

Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.

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