The euro and the pound sterling plunged sharply against the US dollar, and there are tangible reasons for that. EUR/USD dropped to about 1.1153 from 1.1229 on Tuesday morning, and GBP/USD to 1.3331 from 1.3449 — meaning yesterday's recovery after Friday's sell-off was wiped out in one day. As recently as the day before, further declines in the popular currency pairs were in doubt, and the main catalyst that closed that question in the dollar's favor was a strong US inflation report that came in above forecasts.
What the official data shows: the Consumer Price Index rose 0.4% month?on?month in October versus a 0.3% forecast and after a 0.6% increase in September. The main driver was higher prices for necessities: food prices grew at the fastest pace since April, electricity gained 0.9%, and auto insurance hit its highest level in more than a year. The core index, excluding food and energy, climbed 0.3% versus a 0.2% forecast and after 0.3% in September — it has beaten expectations for the third month in a row. Besides, the three?month annualized core rate is about 3.75%, the highest in more than two years. There is no year?over?year figure in the official report because data collection in October last year was interrupted by the US government shutdown, but economists estimate annual core inflation at about 2.8% versus 2.6% in September.
The market reacted immediately. The probability of a Fed rate hike on December 9, according to market calculations, surged to 96.3% from 78.8% on Monday. Market participants are now talking as if it's a done deal. I remind you that the federal funds rate currently stands at 3.75–4.00%. At the policy meeting on October 28, the decision to pause was taken on a 10–2 split. Importantly, Christopher Waller said before the data were released that he was prepared to support a 25?basis?point hike and would consider 50 bps if core prices rose by 0.3% or more, whereas on September 3, he had been willing to hold interest rates given continued progress. I believe the threshold he set has now been crossed. After the inflation data, Lorie Logan mentioned at least two 25?bp hikes and allowed for an acceleration in pace.
Other Fed speakers have been just as hawkish. Anna Paulson said she favors higher interest rates and would like to act faster if inflation expectations continue to rise. Apparently, even lower oil prices will transmit into prices and second?round effects, so the Federal Reserve will likely need to act more aggressively next year as well, and that is already being priced into the dollar. Austan Goolsbee called the October report worrying and noted that tariffs and high energy prices, while easing somewhat, will continue to push on inflation. I'll add that Goolsbee's tone was much firmer than in October, when he left both a hike and a pause on the table; on November 9, he compared the construction of data centers to overheated demand. Since the start of the week, such statements have come one after another, leaving traders with little choice but to buy the dollar and sell the euro and the pound.
Why didn't cheaper oil help? Brent sank nearly 6% on Monday and closed at its lowest since August, but oil jumped roughly 12% in October, so the easing effect will only show up in November inflation data; the Federal Reserve is watching secondary effects today. In my view, as long as inflation expectations do not subside, oil will remain background noise rather than an argument for a pause.
As for today, the main event in the eurozone will be Germany's inflation report. The CPI is expected to fall 0.2% month?on?month after a sharp 0.6% increase in September, and to be around 2.8% year?on?year. If the data are softer than the consensus, that will weaken the euro further because lower inflation could affect ECB plans, even though eurozone headline inflation in October was 4.0% versus 3.8% in September. The deposit rate is now 2.50%, and a rate hike to 2.75% on December 17 is seen as the final one. Christine Lagarde's remarks today are unlikely to be dovish — on October 29 she said the board discussed tightening, so without major developments in December, the direction is clear. Bundesbank President Joachim Nagel will also make his comments; he has taken an equally hawkish stance: on October 16, he did not rule out further moves and was reportedly among supporters of a December hike in early November. I wouldn't rule out a short-term corrective bounce in the euro after yesterday's large sell-off.
There is no major UK economic data today, so the pound sterling has nothing to lean on. Yesterday's releases didn't help: BRC retail sales rose 1.1% versus a 1.2% forecast, and 30?year gilt yields were 5.54%. There is also no major US data today, so the focus remains a strong labor market, high inflation, and unified Fed rhetoric suggesting further rate hikes. That's positive for the dollar and negative for the euro, the pound and other risk assets, and I doubt this backdrop will change before Friday's factory inflation data.
Technical picture for EUR/USD
According to the 1-hour chart, in the case of a small euro correction toward 1.1170, a false breakout there would be a reason to open short positions aiming for a return to 1.1138. A break and close below that area would open the way to 1.1108, with a further target at 1.1082, where I'd look to buy a bounce for a 20–25 pip move. I consider long positions from 1.1108 either on a retracement after a false breakout, or on a similar false breakout from 1.1138. If bears show no strength at 1.1170, it's better to postpone short positions until 1.1193 if the instrument fails to hold near the moving averages, or to consider shorting a bounce from 1.1218 for a 20–25 pip move.
Technical picture for GBP/USD
For GBP/USD, the setup is the same. I expect the first active bearish moves on a false breakout at 1.3353, targeting 1.3325. A break of that range and intermediate support would increase pressure and open the pound's path to 1.3298, with a more distant target at 1.3282, where I'd look to buy a bounce for 20–25 pips. Long posiitons from 1.3298 and 1.3325 are considered only on false breakouts, with 1.3353 as the upside target. If bears are inactive there, I'll delay short positions until 1.3377 on a failed hold, and look to sell bounces just above the moving averages from 1.3404 for a 20–25 pip move.
I'm poised to predict continued pressure on the euro and the pound until Friday's producer?price data, with the market focusing on hawkish Fed rhetoric and bets on further rate hikes next year. I'd venture that soft German inflation combined with a hawkish tone from Christine Lagarde and Joachim Nagel will only produce a correction in the euro, and the pound, lacking its own drivers, will likely follow.