Currencies: Dollar erases inflation-fueled gains as momentum wears off

The U.S. dollar erased gains scored after a stronger-than-expected inflation reading early Wednesday, dipping back into negative territory as market participants assessed the data.

Meanwhile, the Japanese yen rallied to its highest since September 2016.

What are currencies doing?

The ICE U.S. Dollar Index DXY, -0.68% which measures the currency against six main rivals, slipped 0.6% to 89.154, after previously pushing above the 90 barrier. The broader WSJ U.S. Dollar Index BUXX, -0.69% was up 0.6% at 83.21.

The greenback declined sharply against the Japanese yen USDJPY, -0.83% USDJPY, -0.83% dropping through the ¥107-level just one day after breaching the psychologically important ¥108 mark. One dollar last bought ¥106.92, down from ¥107.82 late Tuesday, after touching a session low of ¥106.72.

The yen has been on a steady climb this week owing to uncertainty surrounding global markets after last week’s meltdown for equities. The yen is considered a haven in times of economic and financial upheaval.

Read: Japanese yen hits 5-month high, breaks through technical barrier

Also read: Why the yen is a barometer of how much the equity downturn infects currencies

Versus the Swiss franc USDCHF, -0.5561% also a haven asset, the dollar fell to 0.9298 franc from 0.9350 franc late Tuesday.

The British pound GBPUSD, +0.7341%  rose to $1.3986 as the dollar strengthened, from $1.3894 late Tuesday. Meanwhile, the euro EURUSD, +0.7123%  climbed to $1.2426, from $1.2354 late Tuesday.

Read: Here’s what Germany’s next finance minister could mean for the euro

The buck also reversed against other major rivals that it rose against earlier in the day, including the Canadian USDCAD, -0.5718% and Australian AUDUSD, +0.6617% dollars. One dollar bought C$1.2533, up from C$1.2593. The Aussie dollar bought $0.7906, up 0.6%, while the kiwi—as New Zealand’s currency NZDUSD, +1.2785% is known—was up 1.2% to $0.7364, according to FactSet data.

What is driving the market?

The U.S. dollar briefly jumped higher as January consumer price inflation rose 0.5% and beat expectations of a 0.4% increase, but pared its gains as the session went on. The core figure was also stronger than expected, climbing to 0.3% versus 0.2%. On the year, however, CPI was unchanged at 2.1%. Within the hour of the data, however, the reaction tapered off and the dollar index was only marginally higher.

The data is being viewed as a guide to the Federal Reserve policy path. The central bank is expected to up interest rates three times this year—starting in March—but expectations of a possible fourth rate increase had began to grow earlier this year, when the Fed shared its forecast of an inflation pickup this year. Still, market participants are looking for a prolonged pickup in activity over the next months to strengthen that thesis.

While the dollar rose against most of its rivals on the back of the data, it remained weaker versus the Japanese yen, which benefited from reports showing Japan posted an eighth straight quarter of economic growth—rising an annualized 0.5% in the October-December period. Japan has now seen the longest run of growth in 28 years, even though the fourth quarter grew at a much slower pace than a revised 2.2% in the previous three months.

That growth streak could cast further doubt on the need for the Bank of Japan to keep propping up the economy with ultra-easy monetary policy.

What are strategists saying?

”It was a bit of a mixed bag because inflation had a positive read, while retail sales disappointed, which could be an indicator for a late-cycle U.S. economy,” said Viraj Patel, FX strategist at ING. “The dollar did well against risk currencies like the Canadian, Australian and New Zealand dollar, but it didn’t against the euro or the Japanese yen.”

“Overall, the reaction was actually rather muted,” Patel said.

“Caution is warranted in over-interpreting the [CPI] number” said John Velis, macro strategist at State Street. “January was always going by to be a tough month to forecast CPI this year, but until we get some less worrying inflation numbers this theme will continue.”

What are the data?

Besides inflation numbers, the government also reported January retail sales, which declined 0.3% compared with the consensus forecast for a 0.2% rise. Excluding car sales, the measure fell 0.2% versus 0.4% growth expected.

Business inventories for December rose 0.4%, in line with previous growth.

Which other currencies are in focus?

The South African rand USDZAR, -2.3133%  rallied on Wednesday, helped by the ailing dollar, even though South Africa’s President Jacob Zuma, who is considered a market unfriendly politician due to alleged corruption and public finance issues, clung onto power. The leadership of the African National Congress has given Zuma 24 hours to hand power over to Cyril Ramaphosa, the deputy president and party leader, but he has thus far refused to step down.

Zuma, who is being pressured to go amid corruption allegations and a stagnating economy, is expected to respond to the ANC’s decision to recall him on Wednesday. One dollar last bought 11.6915, down 2.3%, according to FactSet data.

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