USD: It’s not just tariff-inflation
The September CPI release, arguably the most pivotal data point this week, is now scheduled for October 24 at 8:30 ET, delayed due to the ongoing government shutdown. In the interim, a limited stream of pre-shutdown releases and private sector data continues to paint a familiar picture: a cooling labor market, and consumer spending holding firm. This backdrop keeps the Fed on track for another 25bp rate cut at its late October meeting. This was confirmed yesterday by Fed Chairman Powell during an annual speech. Powell pointed to the slow pace of hiring, noting that it may weaken further and that further declines in job openings might eventually lead to higher unemployment. Powell’s remarks put a cap on the Dollar’s momentum, though it is still holding up above the 99 level and 1.5% up month-to-date. Furthermore, US-China tariff tensions keep the markets on edge, as the VIX index has creeped back above the 20 level.
On the inflation front, the dynamics beneath the surface are evolving in ways that complicate the Fed’s policy calculus. Tariff-related price pressures, once a modest drag, are now contributing to headline inflation, notably in core goods. While the August data showed only a 0.23%-point boost from tariffs, the shift from deflationary to inflationary pressure in core goods marks a meaningful change. Categories like household furnishings and recreational goods are seeing more pronounced effects, while others such as apparel and vehicles remain muted, underscoring the uneven transmission of trade policy into consumer prices.
More critically, the persistence of inflation is increasingly rooted in domestic demand, particularly in core services excluding housing, a segment that comprises over half of the PCE consumption basket. According to the San Francisco Fed, recent price increases in this category are demand-driven, not supply-constrained. Both core goods and non-housing core services are currently contributing roughly 0.3 percentage points above target-consistent inflation, suggesting that inflationary pressures are broad-based and not easily reversible.
The Dallas Fed adds that while tariff effects may fade, “further slowing in non-housing core services is not obvious.” This aligns with the latest FOMC minutes, which push back against the notion that tariffs are the primary inflation driver. Only “a couple” of participants attributed high inflation solely to trade policy, while several emphasized that progress toward the 2% target had stalled even when excluding tariff effects. This entrenched inflation is most visible in the services sector, where prices are “stickier” due to their dependence on domestic labor costs and shelter. Elevated wage growth, a byproduct of a tight labor market, feeds directly into higher business costs, which are then passed on to consumers. This wage-price feedback loop is a key source of inflation persistence and cannot be resolved through trade policy adjustments alone. Controlling services inflation will require signs of labor market slack.
The Fed’s cautious, data-dependent stance reflects this reality, with close monitoring of indicators like the unemployment rate, job vacancy ratios, wage growth, and the quits rate. These metrics are essential for assessing whether inflationary pressures are sustainably easing.
EUR: Euro finds relief in politics, not data
Germany’s ZEW survey data released yesterday broadly undershot expectations on both the current situation and expectations components, while sentiment for the broader euro area also deteriorated – October’s expectations reading came in lower than September’s. The sentiment data reinforces what hard indicators have already shown this month: an economy grappling with stagflation, following disappointing industrial production and factory orders earlier in October.
ECB’s Villeroy added to the dovish tone, stating that the next move for the ECB is more likely to be a cut than a hike – supporting our view that supply-driven inflation shocks – feared by the ECB – are less persistent than demand-driven ones, the latter being less of a concern amid stagnant domestic demand.
Yet the euro held firm against the dollar yesterday, climbing 0.3%. The push was driven more by sentiment than fundamentals. Prime Minister Sébastien Lecornu, reappointed last Friday, appears to have secured support from the center-left Socialists by suspending the controversial pension reform – namely, the plan to raise the retirement age from 62 to 64 – until after the 2027 presidential election in a bid for political stability. While political risk remains elevated, the move offered markets a moment of relief: the FR/DE spread narrowed by several basis points, and the CAC 40 pared back some losses.
Overall, it made sense to see the bruised euro shrug off fundamentally driven, dovish headlines, while embracing a more sentiment-led and much-needed rebound.
GBP: BoE and IMF align on UK growth risks
Sterling suffered some losses yesterday, as soft labour market data in the morning extended dovish wagers. Markets priced in around 7 basis points of easing by the December meeting, rising to roughly 8.5 basis points – though expectations were reined in, as anticipated, by lingering sticky price pressures.
Central bankers added fuel to the move. MPC member Taylor, a known dove, called for further rate cuts – a predictable stance – warning that weak domestic demand today could trigger a more forceful economic downturn. He flagged the risk of a hard landing, echoing the IMF’s freshly released forecasts, which show the UK facing the highest inflation in the G7 next year and the weakest growth in living standards, with GDP per capita expected to lag behind its G7 peers.
Adding to the caution, speaking at the Institute of International Finance event in DC, Governor Bailey noted signs of softening in the UK’s job market. He appeared less concerned about inflation drivers, suggesting that a downturn in the economy could drag growth lower in the future. However, little guidance was offered on the path ahead for rates.
GBP/USD bounced off support at 1.3250 after a 0.1% decline, driven more by US-side developments since yesterday evening. Signs that the Fed may be more willing to cut – amid Powell’s renewed concerns about labour market softness and a fresh trade spat between China and the US – helped lift the pair. Technically, repeated tests of the 1.3250 support level in recent days prompted buyers to re-engage more forcefully, as hopes for a more directionally assertive tone from non-obviously-dovish rate-setters faded.
CHF shows steady demand amid rising trade tensions
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Calendar: October 13-17
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