The U.S. dollar hit a two-month low against the euro on Wednesday after the new U.S. consumer price index data signaled cooling inflation in March.
The dollar index — which tracks the currency against other major peers — also hit a one-week low of 101.45. The dollar weakened against the Japanese yen, falling by 0.4 percent to 133.190 yen.
It traded 0.5 percent lower against the sterling to $1.2462. Meanwhile, the euro strengthened by 0.8 percent to trade at $1.1004, its highest value against the greenback since early February.
Consumer price data in March showed year-over-year headline inflation of five percent, its lowest rate since May 2021. The rate was lower than the earlier estimates of 5.2 percent and significantly declined from the headline rate of six percent in February.
"A modestly softer-than-anticipated US inflation report, which appears to have thrown another Fed rate hike in May in a bit of jeopardy."
Matthew Ryan, Head of Market Strategy at Ebury
Ebury head of market strategy Matthew Ryan said the softer-than-anticipated data could prompt the Federal Reserve to pause its monetary tightening campaign in the next policy meeting.
Investors usually opt to invest in the safe haven dollar when central banks raise their benchmark rates to protect the value of their assets. Ryan explained that the decline of the dollar on Wednesday was a "slight overreaction" by the market.
"[Core] inflationary pressures, which we assign far greater importance, remain strong," Ryan said. "Our favored metric, the three-month annualized core inflation rate, continues to print well above the Fed's target at 5.1%."
Futures tied to the Fed's policy indicate a 67.2 percent chance that the U.S. central bank will raise the interest rate by 25 basis points next month, a drop from the 72.9 percent chance of an interest rate hike on Tuesday. The market also expects the Fed to begin cutting the interest rate in July.
Comerica Bank chief economist Bill Adams said the stability in major equity indexes, higher consumer confidence, low unemployment rate and solid job growth in March supported further rate hikes by the Fed. Adams, however, noted that several Fed officials had already justified a rate hike pause.
Chicago Fed President Austan Goolsbee said Tuesday that the central bank should be cautious in determining its next action. He explained that the banking turmoil in March would likely lead to tighter lending conditions, adding the situation could hamper the authorities' efforts to manage inflation.
The Fed began increasing the benchmark rate in March 2022, with the objective of bringing down inflation to two percent. Fed officials have emphasized the importance of using economic data as a basis to determine the rate policy.
‘Hard landing’ possible for U.S. economy
The International Monetary Fund (IMF) has warned that the U.S. economy could face a "hard landing" due to its central bank's tight monetary policy. Hard landing refers to an economic downturn following a period of growth. According to the IMF, it is because the hawkish policy begins to show its impact on the financial sectors.
Analysts also noted that investors shied away from the riskiest U.S. corporate debt, shown by an increasing divide between the highest- and lowest-rated firms in the high-yield bond market. Many investors have sold their low-rated bonds, also known as junk bonds, as they fear that an economic downturn can lead to credit defaults in high-risk enterprises.
The average yields of double-B rated U.S. bonds fell to 6.8 percent from a peak of 7.5 percent seen before the banking crisis. Falling yields indicate that there are many investors purchasing bonds in that category.
On the other hand, triple-C and lower-rated bonds currently yield 15.3 percent, well above the level seen two months ago.