Cooling inflation is unlikely to derail the dollar from getting stronger

Much of the focus this week was on the US inflation data. In fact, the markets moved the most when the US CPI and PPI data were released on Wednesday, respectively, on Thursday.

Higher inflation forced the Federal Reserve to embark on a tightening cycle. At the same time, it shrinks its balance sheet in a process known as quantitative tightening (i.e., the opposite of quantitative easing).

So this week’s data, which referred to the change in the prices of goods and services in March, was closely monitored by market participants. What will the Fed do after the March print?

As it turns out, inflation is cooling off. However, despite the disinflationary process in full swing, the next leg for the US dollar should still be higher. That is, the Fed remains on track for delivering yet another hike at its next meeting.

Core inflation remains stubbornly high

The March Consumer Price Index (CPI) declined to 5.0% YoY. Good news for those hoping to see inflation cooling off.

But the Fed’s favorite measure of inflation excludes food and energy prices. It means that the Core CPI is seen as more appropriate. It came out at 0.4%, not enough for the Fed to announce the reaching of the terminal rate in this cycle.

Nevertheless, the dollar declined on the news, as reflected by the EUR/USD exchange rate moving above 1.10. Moreover, the dollar took another beating when the PPI or wholesale inflation data was released one day later.

This time, the disinflationary process was more evident, as the PPI or Producers Price Index declined by -0.5%, whereas the market expected no change.

To sum up, the dollar traded with a bearish tone all week, as incoming data appeared to support more weakness. But the Core CPI reading for March gives contrarian traders hope that the next leg the dollar will make will be rather higher than lower.