Dollar little changed as U.S. inflation data poses quandary for Fed

By Herbert Lash

NEW YORK (Reuters) -The dollar traded little changed on Tuesday after strong consumer price data revived the likelihood that the Federal Reserve will hike interest rates next week as fears of turmoil spreading in the banking sector faded.

The dollar index, a measure of the greenback against six other currencies, fell 0.087% as Treasury yields jumped a day after the two-year note, which moves in step with interest rate expectations, plunged the most in a single day since 1987.

The euro edged up 0.09% to $1.0739, but the dollar gained against the safe-haven yen and Swiss franc.

Fed funds futures showed the market’s risk adverse mood in recent days eased as bets that the Fed would stand pat at its policy meeting March 21-22 declined. That probability fell to 28.4% from 43.9% on Monday, according to CME’s FedWatch Tool.

But with the likelihood of a 50 basis point hike next week off the table, the dollar’s recent strength from higher rates on Treasury notes than foreign government debt also retreated.

The collapse of Silicon Valley Bank and Signature Bank (NASDAQ:SBNY) last week suggests greater Fed scrutiny of the banking sector may be in store as credit tightens.

“Risk around bank lending is skewed to the downside,” said Thierry Wizman, Macquarie global rates and FX strategist in New York. “With the regulatory burden and the prospect of net interest margins at banks getting squeezed, you can make the case that it’s only going get worse.”

Americans faced persistently higher costs for rental housing and food in February, challenging the Fed to bring inflation under control while stabilizing financial markets after the bank failures.

Futures priced in perhaps two Fed rate cuts by year’s end, with the terminal rate seen at 4.179% in December, down from more than 5% last week.

The Consumer Price Index (CPI) rose 0.4% last month after accelerating 0.5% in January. In the 12 months through February, the CPI increased 6.0%, a slower pace than the 6.4% annualized gain in January, but still far off the Fed’s 2% target.

The Japanese yen weakened 0.69% at 134.13 per dollar, while the greenback rose rose 0.15% against the Swiss franc.

Sterling was down 0.05% at $1.2175 after jumping 1.22% on Monday. Data on Tuesday showed UK pay growth slowed in the three months to January.