13.02.202500:36 Forex Analysis & Reviews: EUR/USD: Inflation, the Federal Reserve, and Market Expectations

Inflation in the U.S. has accelerated again. The Consumer Price Index (CPI) report released on Wednesday favored dollar bulls, with all components exceeding expectations. Given recent statements by Federal Reserve Chair Jerome Powell, this one-sided result suggests that the Fed will maintain interest rates at their current level in the coming months.

Moreover, if key inflation indicators continue to rise, the market may start considering a longer pause—potentially until the end of the year. While a rate hike still seems unlikely (though this depends on inflation trends), the possibility of "no rate cuts in 2025" is becoming more plausible. Back in December, Powell indicated that the Fed was nearing the end of its monetary easing cycle. The updated dot plot from the Fed's December meeting projected only 50 basis points of rate cuts in 2025. If inflation continues to accelerate, this forecast could be revised in March—downwards, of course.

Returning to the report, all its components were in the "green zone." For example, on a monthly basis, the overall CPI rose to 0.5% (forecast: 0.3%)—the fastest pace since September 2023. Moreover, this indicator has been rising for three consecutive months after stagnating at 0.2% from July to October. On an annual basis, headline CPI also beat expectations, accelerating to 3.0% (forecast: 2.9%), marking four consecutive months of steady growth.

Core CPI, which excludes food and energy prices, increased by 0.4% month-over-month (forecast: 0.3%) and to 3.3% year-over-year (forecast: 3.1%). From September to November, core CPI held at 3.3% YoY, dipped to 3.2% in December, and has now returned to its previous level.

The report also shows that, for the first time in six months, U.S. energy prices rose (+1.0% YoY after a -0.5% decline in the previous month). Natural gas prices jumped 4.9%, transportation services surged 8% (vs. 7.3% in December), food prices increased 2.5%, and used car prices rose 1.0%. Gasoline prices fell slightly (-0.2% after a -3.4% decline in December), as did new car prices (-0.3% vs. -0.4% in the previous month).

The importance of the CPI cannot be overstated. First, the report solidified market confidence that the Fed will keep interest rates unchanged for at least the next two meetings. According to the CME FedWatch Tool, the probability of the Fed maintaining rates in March is now at 98%, while the likelihood of a rate cut in May has decreased to just 11%.

Second, the market has revised its forecasts for the June meeting. In January, the probability of maintaining the current rate was 25%. Following the January Nonfarm Payrolls report, this probability rose to 50%. After the inflation data, it has jumped to 65%.

This leads back to Jerome Powell's remarks during his testimony before the Senate on Tuesday. He presented the Fed's semi-annual report and answered questions from lawmakers. When asked about the conditions under which the Fed would consider additional rate cuts, Powell indicated that the Fed would ease policy further only if inflation decreased faster than expected or if the labor market weakened significantly. He also noted that inflation remains elevated, and while the labor market, which was previously overheated, has only "cooled slightly," it remains stable.

It's important to note that these statements were made before the release of the CPI report. We can now confidently say that inflation is not moving toward the Fed's target; instead, it is moving in the opposite direction. This suggests that the Fed is likely to continue its wait-and-see approach for the foreseeable future. Previously, the market was pricing in a June rate cut with high confidence, but it is now having second thoughts.

A similar scenario occurred last year, when market expectations shifted multiple times due to dovish sentiments. In January 2024, most market participants anticipated that the Fed would cut rates in March. However, by February, it became clear that inflation would prevent the Fed from acting that early. Subsequent spring inflation reports pushed expectations for monetary easing into the second half of the year.

If inflation does not begin to decrease in the coming months, and if the labor market remains strong, the Fed may extend its pause on rate changes until 2026.

The report has bolstered the U.S. dollar and strengthened the position of EUR/USD bears. The significant price fluctuations observed on Wednesday—dropping to 1.0318 and then rebounding to the resistance level of 1.0380—seem to be driven more by emotion than by rational decision-making. There are no strong fundamental reasons for a trend reversal or sustained price growth.

In my opinion, there are two preferable options at this time:

1. Sell on corrective upward movements.

2. Sell after a confirmed decline below the support level of 1.0340, which coincides with the middle line of the Bollinger Bands on the H4 timeframe and aligns with the Tenkan-sen line.

In the second scenario, the Ichimoku indicator will generate a bearish "Three-Line Strike" signal. The downside targets are 1.0280 (the lower Bollinger Bands line on the H4 chart) and 1.0250 (the lower Bollinger Bands line on the daily chart).