The new Consumer Price Index (CPI) data has done a number on those expectations. Today, additional Federal Reserve interest rate cuts are as likely as they’ve ever been. As a result, in June annualized headline CPI inflation rocketed up to 2.7% y-o-y. Consequently, investment analysts have pushed back their predictions for the first cut to September. The odds the Federal Reserve will stay with its currently established interest rates have soared to 44%. This increase occurs while inflation remains well above the central bank’s target range of 2%.
On Tuesday morning, the EUR/USD exchange rate dropped sharply. It sank by over eight-tenths of one percent, for its lowest close in almost three weeks. This drop is a sign of overall market sentiment as investors continue to re-evaluate their positions following a series of strong economic indicators.
Changes in Rate Cut Predictions
As noted above, the Federal Reserve’s interest rate decisions are inextricably linked to inflation and unemployment, specifically those two metrics. Economists suggest that the central bank may consider lowering rates only when inflation falls below its 2% target or if the unemployment rate rises significantly. This policy framework has initiated a reconsideration of what we should expect. Yesterday’s release of the June CPI report confirms that inflation continues to move in the wrong direction.
Based on this data, investors have all but removed an expectation for a September rate cut. This dramatic change has depressed what had been aspirations for swift monetary easing. As of today, there’s an 80% chance that we’ll get at least a quarter-point cut in October. More changes to come in December! This trend is indicative of how major market participants have begun to lose their risk appetite. Now, with inflationary pressures continuing, they are weighing possible risks much more judiciously.
Market sentiment is still positive for future rate cuts, with futures projections showing two of them happening in 2025. This picture of optimism differs markedly from the short term view, where a hawkish turn in expectations for September has created downward pressure on the policy path.
The Impact of CPI on Currency Markets
The latest CPI data has produced an obvious reaction in currency markets, most notably impacting the EUR/USD cross rate. Our local exchange rate has fallen down to its worst bids in close to 3 weeks. This serves to underscore the fragility of currency valuations to news on economic data. As inflation increases, the Greenback tends to strengthen. The potential for future rate cuts is enough to keep its value underwater by a large margin.
The plunge in the EUR/USD exchange rate indicates that investor confidence is waning. They are positively treading lightly on the U.S. monetary policy short-term trajectory. With soaring, persistent inflation, borrowing costs are sky-high. Consequently, market participants are adjusting or re-adjusting their trades ahead of possible future firmer actions by the Federal Reserve.
When the Fed lowers interest rates, it encourages more borrowing and spending in the broader economy. In reality, this practice frequently has the effect of depreciating the currency in question. What the Federal Reserve does or doesn’t do with its interest rate policy will be of supreme importance to us at home, too. It has done to massively change international currency dynamics.
Future Expectations and Economic Indicators
Going forward, Federal Reserve policy actions will be determined based on key economic data, specifically inflation data and unemployment rates. The central bank has a long-standing goal to keep inflation at 2%. Given that current CPI inflation is well above that threshold, any meaningful monetary easing will probably be postponed until there’s an unambiguous sign of inflation coming down.
Investors are keeping a close eye on inflation trends. Consensus opinion is that the Fed will not cut rates anytime soon. There is keen expectation that there will be seeker changes in the future. If inflation continues to moderate or unemployment starts to increase, the Fed might have more room to maneuver. This would give them more room to apply across-the-board interest rate cuts.