Economic Analysis and Geopolitical Concerns on USA

Last Friday, I observed a notable surge in the US dollar, triggered by the release of the December US Consumer Price Index (CPI) data. The urgency to validate market expectations of a rate-cutting cycle commencing in March heightened, emphasizing the significance of economic data. Although the data exceeded expectations, it appears insufficient to alter the prevailing consensus of ongoing disinflation. This sentiment was evident in the foreign exchange (FX) markets, where the initial strength of the US dollar fully retraced, assisted in part by comments from Federal Reserve officials.

US CPI

Source: Finlogix

After an extended period of disinflation across various inflationary elements, it was inevitable to reach a juncture where this trend would diminish, if only temporarily. While it seems, we may have reached that point, there are still valid reasons to anticipate further disinflation. Key takeaways from the data include weak core goods inflation, persistent rent inflation, and a modest uptick in the 'super core.' The focus on 'super core' Consumer Price Index (CPI) may wane if rent inflation significantly decreases. However, for now, the narrative revolves around the rent inflation component, limiting the scope for further disinflation.

The outlook appears favourable based on straightforward base effect calculations. With shelter disinflation, it seems unlikely that month-on-month rates will match those of 2023. Market participants have taken note, with the 2-year US Treasury bond yield down approximately 4 basis points, and the 10-year yield remaining unchanged. While the implied probability for the March meeting hasn't changed significantly, currently standing at 18%, from a foreign exchange perspective, a status-quo scenario in yields may provide room for the US dollar to modestly advance.

US & UK attack on Houthis underline likely Fed caution.

Looking forward, a key geopolitical risk on the horizon involves the potential escalation of the Israel-Hamas conflict in the Middle East. Recent attacks on Houthi rebel targets in Yemen by the US and the UK have heightened these risks. This is particularly evident in the immediate response of the crude oil market, with Brent crude oil up over 2.0%.

President Biden justified the attacks by citing the endangerment of lives, trade, and freedom of navigation in the Red Sea due to Houthi attacks. Iran swiftly condemned the US and the UK, labelling it a breach of international law. Simultaneously, the Houthi rebels pledged to continue attacks on vessels.

The prospect of further escalation seems likely, prolonging the time ships avoid the Red Sea and adding a risk premium to crude oil prices.

Considering this challenging backdrop, it appears difficult for the Federal Reserve to shift its rhetoric and provide guidance on a potential rate cut in March during the upcoming Federal Open Market Committee (FOMC) meeting on January 31. The elevated geopolitical risks in the Red Sea region, causing concerns over supply disruption and rising energy prices, may impede any change in stance.

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