There is still room for further dollar weakness – Commerzbank

Inflation in the US was slightly lower than expected. The economists of commerzbank discuss the outlook for the USD following the US CPI report.

Small surprise in US CPI, big jump in EUR/USD

Most analysts expected the core rate to come in at 0.3% (mom, seasonally adjusted), but it turned out to be slightly lower at 0.2%. And what?, one may wonder. This does not mean that the problem of inflation in the United States is solved. We could see setbacks in the coming months.

The dollar weakened significantly after the release of the data. One might wonder if a relatively small inflationary surprise of absolute magnitude can justify such a reaction from the markets. But we’ve seen similar patterns before. At the last few levels, dollar exchange rates had obviously priced in an unrealistic level of Fed tightening. That part of the USD exchange rates had to correct itself fairly quickly.

The prospect of a reduced USD carry puts pressure on a currency. That’s the simple part of the story. However, there is a complication. It is not just a question of the terminal rate (ie, the rate cap), but also how long interest rates will remain at this elevated level. This means that there is still room for further dollar weakness. Wednesday’s move in markets need not spell the end of dollar weakness.