Original article by FXStreet. Credit: Written by Christian Borjon Valencia
Source: FXStreet – “Fed’s balancing act in focus as inflation lingers and USD/JPY eyes key breakout”
Title: Fed’s Tightrope Walk Amid Persistent Inflation: USD/JPY Poised for Breakout
The financial markets continue to keep a close eye on the Federal Reserve as inflationary pressures remain sticky and economic data points to uneven momentum. The USD/JPY pair, in particular, stands at an important technical juncture as traders weigh future policy moves by the Fed and evolving trends in U.S. macroeconomic indicators.
Following a string of mixed data releases and cautious remarks from the Fed, questions mount regarding when and by how much the central bank can cut interest rates in the coming months. Meanwhile, signs of slow disinflation combined with robust consumer spending are complicating the Fed’s forward guidance, leaving investor sentiment fluctuating and in turn impacting the U.S. dollar and yen dynamics.
Fed’s Ongoing Battle With Inflation
The U.S. Federal Reserve has signaled that it remains on a data-dependent path when it comes to rate decisions. Inflation, which surged during the post-pandemic years, has moderated but remains well above the Fed’s 2% target, which poses a direct tension with calls for rate cuts.
Key points about inflation and Fed policy:
– Core Personal Consumption Expenditures (PCE), the Fed’s preferred inflation measure, remains elevated, with core readings not falling rapidly enough to give Fed officials confidence for immediate easing.
– Latest CPI (Consumer Price Index) and PPI (Producer Price Index) data show inflation stabilizing but not yet decelerating sharply.
– Fed Chair Jerome Powell and other policymakers maintain that more progress is needed on inflation before cutting rates would be appropriate.
– Economic resilience, particularly in jobs and consumption, has meant that inflation risks haven’t fully abated.
– Fed speakers including Atlanta Fed President Raphael Bostic and New York Fed’s John Williams have hinted that easing could be delayed until late 2024 or even beyond, depending on incoming data.
The Federal Reserve finds itself walking a tightrope: too early a rate cut could risk reigniting price pressures, while keeping monetary policy too tight for too long increases the risk of an economic slowdown. As the Fed attempts to engineer a soft landing, financial markets are left to decipher the path forward.
U.S. Economic Outlook Remains Mixed
While the Fed continues to combat inflation, the broader U.S. economy is sending mixed signals:
– Consumer spending has remained better than expected, supported by resilient labor markets and rising wages.
– Nonfarm Payrolls data continue to show strength, albeit with a slowing trend.
– Industrial production has lagged, showing weakness in manufacturing and other sectors sensitive to interest rate levels.
– Services PMIs have remained in expansion territory, signaling sustained demand for services versus declining activity in manufacturing.
Notably, forward-looking indicators suggest that a slowdown could materialize if credit conditions tighten further or if Fed policy remains restrictive for too long. The yield curve remains inverted, historically a possible recession signal. However, high-frequency data does not yet indicate an imminent downturn.
Market Pricing for Rate Cuts Continues to Shift
Financial markets have been adjusting their expectations for Fed rate cuts as they digest macroeconomic data and communication from Fed officials.
– Early in 2024, markets were pricing in up to six rate cuts. Those expectations have since narrowed to one or two cuts by year-end.
– Fed Funds Futures show a strong probability of a rate cut by December, but growing uncertainty about any policy change before then.
– Policymakers have repeatedly emphasized a data-driven approach, meaning the June and July inflation reports could be decisive in determining next steps.
Lingering inflation risks and a still-tight labor market make policymakers hesitant to commit to a dovish pivot. Nonetheless, market participants continue to hedge for either a soft-landing scenario or potential stagflation, depending on how incoming data develops
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