Fed Raises Rates & Upgrades “Dot Plot” As Inflation Meets Positive Forecasts

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Inflation Rises In Line With Expectations

USD bulls were given some encouragement this week as the latest data showed May inflation in the US printing in-line with expectations, with the headline measure rising 0.2% month-over-month. This latest increase raises the inflation rate to 2.8% from 2.5% in April, marking the fastest increase since 2011. The increase in inflation was driven mainly by higher gasoline prices which increased by 1.7% month-over-month, offsetting the declines seen elsewhere in other energy components alongside no movement in food prices.

Core CPI also came in-line with the market forecast, rising 0.2% month-over-month, moving the annual core reading up to 2.2% from 2.1% over the prior month. However, core goods remained soft, falling -0.1% on the month and declining -0.3% on the annual reading. The recent bout of USD strength is potentially acting to further constrain the already limited pass through effects from past USD depreciation.

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Looking further at the data, used cars and trucks also continued their downward trajectory due to the wave of vehicles that have come off leases, falling -0.9% month over month. Apparel was unchanged on the month while the strongest contribution came from medical care with prescription drugs jumping 1.4% month over month. Core services rose 0.3% month over month and 3% year over year led by shelter. The rest of core services, however, was soft as medical care fell -0.1% and both core transportation and recreation were flat on the month.

This latest inflation report confirmed the continued improvement in CPI for the Fed, which has been helping to life PCE inflation to the Fed’s 2% target. With this in mind, the Fed raised rates at its June meeting and also upgraded the dot plot for the rest of the year, forecasting two further hikes from one prior hike.

Policymakers have said that they are comfortable with a modest overshoot in inflation and this data doesn’t require any adjustment in that view. Unless oil continues its recent rally and moves sharply higher still, headline inflation should moderate heading into the third quarter. Base effects meanwhile, are likely to weigh slightly on year over year inflation by late 2018. This is of course unless we see a sharp increase in the monthly rate of CPI increases.

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Fed in Focus

As expected, the Fed raised rates at its June meeting with policymakers voting unanimously in favour of the action. The statement released alongside the decisions noted that job growth has been “strong” with recent data also suggesting that “household spending has picked up”, alongside better business fixed income investment, which “continued to grow strongly”.

The most notable hawkish shift in the statement was the removal of language suggesting that accomodative policy would remain in place for “some time”.  This language had been in place for years and the removal now, along with the Fed upgrading its rate hike forecast for the rest of the year, is extremely encouraging for USD bulls.

However, the market reaction was counter intuitive with the USD dropping after the meeting in response to reports that President Trump is preparing to apply tariffs to billions of dollars of Chinese goods, as soon as Friday. The news has caused a sharp uptick in investor uncertainty with many fearing damage to the US growth outlook from such a move, as well as concerns for Chinese retaliation.

Technical Perspective

technical perspective

After finding support at the test of the late 2017 lows around 1.1546, EURUSD has since bounced higher and is making moves back toward the 1.20 – 1.21 resistance level. This could prove to be the right shoulder of a larger head and shoulders pattern, suggesting the potential for a larger downside move in EURUSD over the coming months. A break of that resistance level, however, will bring the 2018 high into focus.

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