The week is set to close off with major events on the economic calendar, giving us some potential for volatility in USD-denominated pairs. At 8:30 EST (or 14:30 CET) we have the release of US inflation data, which everyone is interested in because that’s part of the Fed’s mandate.
Given the softer tone from the Fed about rates going forward, analysts will be keeping an eye on inflation, and whether it increases enough to motivate a change in outlook.
There are several items of inflation data that come out at once, and they each give different information for the markets. As a reminder, the general rule is that as inflation goes up, the currency gets weaker and if inflation goes down, the currency gets stronger.
However, lately, that has functioned in reverse as higher inflation is seen as increasing the potential the Fed will raise rates and strengthen the currency. The Fed cares about the annual core inflation rate, and consequently, that is generally the data point that moves the market immediately.
However, the data that the market focuses on excludes food and energy costs, which are more volatile. While not so immediately relevant to monetary policy, food prices and especially fuel prices, are still relevant to economic performance, and the underlying cost of doing business. Fuel might not be considered in the core inflation, for example, but it clearly is a factor in transportation costs.
Increasing inflation is typically associated with a growing economy. Excess inflation is a sign of an overheating economy. However, overall, inflation peaked in July and has since been trickling lower (despite predictions of increased costs due to US tariffs on China), followed by the stock markets in the last quarter.
The drop in CPI might be giving us a heads-up about a disappointing GDP figure, although job creation during the same period has been above average.
Core Inflation Rate
The Fed sees a core inflation rate of around 2% annual as consistent with their mandate. Since March of this year, the rate has been consistently above 2% and reached a high of 2.5% in July.
Current expectations are for inflation to stay steady at the prior month’s 2.2%. This would include an expectation for a monthly increase in inflation of 0.2% (again, same as the month before.)
Consumer Price Index
If we add in fuel and food costs, the expectation is for the rate to fall to 1.9% annual from 2.2% in the prior month. This would imply a monthly inflation rate of -0.1% compared to flat in the prior month. Factors that influence this is the drop in crude prices during December.
A factor that analysts who are interested in a deeper appreciation of the economic situation will be looking at, is the shelter component of the data. Shelter includes the cost of rental housing as well as house prices, the latter of which has been increasing well above the inflation rate for years. A slowing pace in shelter inflation could be an indication of exhaustion on the housing market.
The USD dollar, when compared to other currencies, has been having a difficult time lately, having slipped near 2.0% since its peak in mid-December. The EURUSD broke cleanly through the 50 Fibo that had been acting as resistance all through December.
Much more dramatic has been the USDJY which is well on its way to retrace all of its gains from last year:
(Note that the 62 Fibo corresponds with the bottom of the May correction. The last time the USDJY moved like this, and almost mirrored performance was between mid-Dec and Mar of last year.)