EUR/USD: Trading the U.S. Consumer Price Report

Trading the News: U.S. Consumer Price Report

What’s Expected
Time of release:        02/19/2010 13:30 GMT, 08:30EST
Primary Pair Impact :    EURUSD
Expected:         2.8%
Previous:         2.7%

Impact the U.S. Consumer Price Report has had on EURUSD over the last 2 months

December 2009 U.S. Consumer Price Report

Price growth in the U.S. expanded less-than-expected in December, signaling that economic recovery is showing limited signs of inflation. Annualized consumer prices climbed 2.7% following the 1.8% rise in November , while the core reading for inflation added 1.8% from a year ago. Taking a look at the breakdown of the report, service costs, which makes up about 60percent of CPI, edged up 0.9% from the previous year, marking the smallest gain since 1945, while energy costs rose 0.2%. As price pressures remain subdued, the Federal Reserve is likely to maintain its pledge to keep borrowing costs at the record-low of 0.25%, and the central bank may keep interest rates on hold throughout the first-half of 2010 as policy makers aim to encourage a sustainable recovery.

November 2009 U.S. Consumer Price Report

Consumer prices in the U.S. advanced an annualized 1.8% in November after tumbling 0.2% the month prior, with economists’ expectations of 1.8%, figures from the Labor Department showed today in Washington. Meanwhile, price growth climbed 0.4% in the same period following a 0.3% advance the previous month. The increase in the cost of living was largely attributed to higher prices for energy and medical care. Today, central bankers will wrap up their final policy meeting of the year with no change to the benchmark interest rate. At the same time, policy makers reiterated a pledge to keep borrowing costs at a record low for an “extended period,” and specified that policy would stay unchanged for as long as inflation expectations are stable and the labor market remains weak.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.

How To Trade This Event Risk

The U.S. dollar is likely to face increased volatility over the next 24 hours of trading as economists forecast consumer prices to expand to an annual rate of 2.8% in January, and a rise in inflation could stoke speculation for a rate hike as the Federal Reserve aims to normalize policy this year. Nevertheless, a report by the Labor Department showed producer prices in the world’s largest economy increased to an annualized pace of 4.6% in January to mark the highest reading since October 2008, while the import price index advanced 11.5% during the same period as petroleum prices jumped 95.5% from the previous year. Moreover, the advanced 4Q GDP report showed the growth rate increased 5.7% from the previous year to top forecasts for a 4.7% expansion, and price pressures could intensify over the coming months as the nation recovers from its worst recession since the Great Depression.

However, the Federal Open Market Committee held the benchmark interest rate at the record-low of 0.25% in January and reiterated that borrowing costs will stay low for an “extended period” of time as the central bank expects price pressures to remain “subdued” over the coming months. The meeting minutes showed the MPC expects  price growth to expanded at an annual pace of 1.1% to 1.7% this year as the ongoing slack in the domestic economy continues to “restrain cost pressures,” and discussed the possibility of selling assets in the “near future” as policy makers see a need to reduce the Fed’s balance sheet “substantially over time.” In addition, the FOMC went onto say that managing the discount and federal funds rate “would be a key element” for future policy, and noted that there were a “range of views” on how to withdraw the emergency measures. However, MPC member Thomas Hoenig dissented and said that keeping the interest rate at the record-low for an “extend period” period of time was “no longer warranted,” and the central bank may turn increasingly hawkish over the coming months as the recovery continues to gather momentum.

Increased price pressures are likely stoke expectations for a rate hike later this year as the Fed aims to unwind its emergency programs over the coming months, and price action following the data could set the stage for a long U.S. dollar trade as investors weigh the outlook for future policy. Therefore, if consumer prices expand to an annualized pace of 2.8% or higher, we will need to see a red, five-minute candle following the release to generate a sell-entry on two-lots of EUR/USD. Once these conditions are met, we will place the initial stop at the nearby swing high or a reasonable distance taking volatility into account, and this risk will establish our initial target. Our second objective will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in order to preserve our profits.

In contrast, the ongoing weakness in the private sector may weigh on price growth going forward, and subdued inflation will certainly allow the FOMC to maintain a dovish policy stance as they aim to encourage a sustainable recovery. As a result, if the CPI holds at 2.7%, we will favor a bearish outlook for the greenback, and will implement the same strategy for a long euro-dollar trade as the short position laid out above, just in reverse.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com