US Jan CPI and Powell Testimony: Cuts Moving Away

The market focus this week is likely to be on the US dollar with two main events that could shake up the markets. On Tuesday, Fed Chair Jerome Powell will start his semi-annual testimony before Congress. Then the main event is likely to be the release of the latest inflation numbers on Wednesday.

Expectations around what the Fed will do in this relatively uncertain environment are seen as the main drivers for the dollar, and all the currency pairs that it’s related to. The market was fairly certain ahead of the last FOMC meeting that there would be a pause in the rate cutting cycle. But the hawkish tone coming out of the meeting was a bit of a surprise. Powell’s extensive public presence on Capitol Hill during the Powell Testimony might offer an opportunity to clarify what happened at the meeting and what the Fed is expected going forward.

The Changing Views of the Markets

A month ago, there was a fair amount of speculation that the Fed could cut rates again in March. But those expectations have diminished considerably since then, to the point that the market is now practically expecting no rate cut at the March meeting. This has contributed to the recent dollar strength. It has also been supported by the Fed’s more hawkish tone.

If Powell’s commentary during his Powell Testimony were to soften the message a bit, it could give the dollar some reason to retreat. But geopolitics of lately has been a bigger influence in the dollar, as President Trump has confirmed the application of a new round of tariffs. Powell is likely to be questioned about the potential inflationary impact of those moves, and how the Fed is expected to react. But since this whole thing revolves around inflation, the market could be much more focused on the actual Consumer Price Index (CPI) figures that come out on Wednesday.

Getting Back on Track

The latest bump up in inflation over the last few months was widely expected, so higher inflation in itself doesn’t mean the Fed will turn more hawkish. The issue is that inflation is expected to come back down and return to target through the early part of the year. So, the market will be keen to see confirmation of that happening.

If inflation accelerates to the upside, it could be a sign that the expected return to target might not happen in the timeframe expected. That would likely move the market to delay when the next cut could happen, and push the dollar up. On the other hand, a sudden drop in the inflation rate could suggest that the prices are normalizing ahead of schedule and weaken the dollar. Although the downside could be limited by policy changes, as markets seem to be preferring safe havens given the uncertainty around tariff policy.

What to Look Out For

The consensus among analysts is that headline inflation will stay unchanged at 2.9%, which is well above the target at 2.0%. But, that would imply that the winter bump is peaking, and likely would reassure markets. The core rate, on the other hand, is expected to tick down to 3.1% from 3.2%, which could keep future rate expectations on track.

The strength in the labor market as shown by the drop in the unemployment rate in January is also seen as an obstacle to getting rates lower. Traders will likely be looking for signs in the inflation data that labor costs are keeping Consumer Price Index (CPI) buoyant, which would likely leave the Fed inclined to keep rates higher for longer.

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