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

Trading the News: U.S. Consumer Price Index

What’s Expected:

Time of release: 02/17/2011 13:30 GMT, 8:30 EST

Primary Pair Impact : EURUSD

Expected: 1.6%

Previous: 1.5%

DailyFX Forecast: 1.5% to 1.8%

Why Is This Event Important:

Consumer prices in the U.S. are projected to increase at an annualized pace of 1.6% in January, and the rise in inflation could spur a bullish reaction in the greenback as the Federal Reserve raises its outlook for future growth. As the central bank sees economic activity expanding 3.4 to 3.9 percent in 2011, the rebound in price growth could lead the FOMC to curb speculation for another round of quantitative easing as the recovery gradually gathers pace. However, as households cope with the ongoing weakness in employment paired with a depressed housing market, businesses may keep a lid on prices in order to stimulate private demands.

Recent Economic Developments

The Upside

The Downside

With businesses facing higher commodity prices, firms may increase their willingness to pass on higher costs onto consumers, and the rebound in price growth may accelerate over the coming months as private sector activity gathers pace. However, as the expansion in household spending cools, with the region facing a tepid recovery, businesses may look to absorb higher costs in order to draw potential customers. As investors weigh the prospects for future policy, we expect the currency market to show a major reaction to the inflation report, and rising price pressures could instill a bullish outlook for the greenback as the Fed holds an improved outlook for the real economy.

Potential Price Targets For The Release

How To Trade This Event Risk

Forecasts for a faster pace of price growth certainly fosters a bullish outlook for the greenback, and the market reaction to the release could set the stage for a long U.S. dollar trade as the economic recovery picks up steam. Therefore, if the headline reading advances 1.6% or more from the previous year, we will need to see a red, five-minute candle following the data to establish a sell entry on two-lots of EUR/USD. Once these conditions are met, we will set the initial stop at the nearby swing high or a reasonable distance from the entry, and this risk will generate our first target. The 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, firms may keep a cap on consumer prices as households cope with high unemployment, and a soft inflation report could bear down on the exchange rate as investors speculate the central bank to expand monetary policy further over the coming months. As a result, if the CPI holds steady or unexpectedly weakens from the previous month, we will utilize the same strategy for a long euro-dollar trade as the short position mentioned above, just in reverse.

Impact that the U.S. Consumer Price report has had on USD during the last month

December 2010 U.S. Consumer Price Index

The headline reading for U.S. inflation increased at an annualized pace of 1.5% in December to top forecasts for a 1.3% expansion, while the core CPI unexpectedly rose 0.8% for the second consecutive month. The breakdown of the report showed energy prices climbed 7.7% from the previous year, with the cost for food and beverages advancing 1.5%, while price growth for all of 2010 increased an annualized 1.5% to mark the slowest pace of expansion in two-years. As price growth remains subdued, the Federal Reserve is likely to support the real economy throughout the first-half of 2011, and the Board of Governors may keep the door open to ease monetary policy further as inflation continues to hold below the central bank’s 2 percent target. Currency traders initially showed a mixed reaction to the batch of economic developments, but the small pullback in the EURUSD was short-lived as the pair ended the trading session at 1.3373.

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