How the USD Continues to React to the Consumer Price Index

Throughout 2015 and the formative part of 2016, the Consumer Price Index (CPI) in the U.S. hovered precariously above the low rates sustained during the depths of the great recession. This was a trend that was expected to continue well into 2017, particularly given the uncertainty surrounding the nature of incoming President Donald Trump's economic policy.

Despite this, the American economy showcased surprisingly robust levels of growth during the third and fourth financial quarters, even as Trump and the Democratic nominee Hilary Clinton waged the bitter battle to win the Presidency. This resulted in an improved CPI reading in September, which highlighted the renewed strength of the economy and halted a strong EUR/USD recovery.

How December's CPI Increase Has Impact on the USD

This was followed by a further increase in the CPI during December, as prices rose by 0.3% to consolidate the initial gains in September. This also confirmed the largest year-on-year increase in nearly three years, after the index rose by just 0.7% during the whole of 2015. Given that this data was supported by an improving economic outlook and a tightening labour market, it saw a positive response from the USD that continued into the first week of the New Year.

The latest inflation data suggests that the increased CPI may be beginning to have a detrimental impact on the markets, however, with the cost of fuel and rented accommodation rising at a disproportionate rate to earnings. This was confirmed when the Federal Reserve released its latest inflation data, which showcased a sharp increase from 1.7% during the last financial quarter to a startling 2.1%. With headline inflation rising and food energy prices increasing by 1.5% during December alone, there are now serious concerns that this could have a detrimental impact on the USD.

After all, the emergence of disproportionate interest rates casts the U.S. economic landscape in an entirely different landscape. Not only will a rate of 2% prevent the Fed from hiking the U.S. rate beyond the incremental increase it issued in December, for example, but there are suggestions that Donald Trump's reported, $1 trillion stimulus package could push inflation towards 3%. This is bad news for the USD, which is likely to lose ground against the EUR and other currencies as a result.

The Bottom Line: How Rising Inflation is Already Hitting the Markets Hard

In fact, the rising level of inflation has already begun to impact on the economy and the value of the USD, with FX Pro reporting that the currency slipped almost as soon as the data had been released. This also provided a timely boost for the EUR/USD pairing, which rose to 1.06810 from a starting point of 1.06610 at the start of trading.

So while the USD may have retained a core foundation of strength (and continued to outperform the pound) for the time being, this trend will not be sustained if inflation rises at the projected levels during the next two financial quarters. The stimulus package that has been proposed by Trump will have a key bearing on this, as it will cause inflation to rise artificially and at a disproportionate rate to other, macroeconomic metrics.

It also confirms the suggestion that a Trump Presidency will trigger a weaker dollar, which in turn will impact the cost of imports for all U.S. businesses.