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

By , Currency Analyst
12 May 2011 19:52 GMT

Trading the News: U.S. Consumer Price Index

What’s Expected:

Time of release: 05/13/2011 12:30 GMT, 8:30 EST

Primary Pair Impact:EURUSD

Expected: 3.1%

Previous: 2.7%

DailyFX Forecast: 2.9% to 3.1%

Why Is This Event Important:

Consumer prices in the world’s largest economy is projected to expand at an annualized pace of 3.1% in April, which would be the fastest pace of growth since October 2008, and the heightening risk for inflation could spark a bullish reaction in the U.S. dollar as investors weigh the outlook for monetary policy. According to Credit Suisse overnight index swaps, market participants expect to see borrowing costs increase by 25bp over the next 12-months, and mounting price pressures could lead the Fed to gradually normalize monetary policy later this year as it maintains its dual mandate to ensure price stability while fostering full-employment. However, as Fed Chairman Ben Bernanke continues to highlight the ongoing weakness within the real economy and maintains his pledge to retain a zero interest rate policy for an ‘extended’ period of time, the central bank may look to support the economy throughout 2011 in an effort to encourage a sustainable recovery.

Recent Economic Developments

The Upside

Release

Expected

Actual

Producer Price Index (YoY) (APR)

6.5%

6.8%

Import Price Index (YoY) (APR)

10.4%

11.1%

ISM Price Paid (APR)

83.0

85.5

The Downside

Release

Expected

Actual

Advance Retail Sales (APR)

0.6%

0.5%

Average Hourly Earnings (MoM) (APR)

0.2%

0.1%

House Price Index (MoM) (FEB)

-0.3%

-1.6%

Higher commodity prices may lead businesses to pass on higher costs onto consumers, and firms may raise prices throughout the year as price sector activity steadily gathers pace. However, as Americans cope with subdued wage growth paired with the ongoing weakness in the housing market, the slowdown in private sector consumption could encourage businesses to adsorb higher costs, and a slower-than-expected rate of inflation may encourage the Fed to keep the benchmark interest rate close to zero until 2012 as the central bank aims to balance the risks for the nation. In turn, the U.S. dollar may struggle to hold its ground should interest rate expectations deteriorate, and the EUR/USD may continue to retrace the sharp decline from earlier this year as the Mr. Bernanke maintains a dovish outlook for monetary policy.

Potential Price Targets For The Release

EURUSD_Trading_the_U.S._Consumer_Price_Report_body_ScreenShot043.png, EUR/USD: Trading the U.S. Consumer Price Report

How To Trade This Event Risk

Projections for a fastest pace of inflation certainly reinforces a bullish outlook for the greenback, and the market reaction following the report could pave the way for a long U.S. dollar trade as investors speculate the FOMC to gradually normalize monetary policy later this year. Therefore, if consumer prices increase at an annual pace of 3.1% or higher in April, we will need a red, five-minute candle following the release to generate a sell entry on two-lots of EUR/USD. Once these preconditions are fulfilled, we will set the initial stop at the nearby swing high or a reasonable distance from the entry, and this risk will establish our first objective. The second target 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 an effort to lock-in our profits.

On the other hand, firms may continue to adsorb higher costs in order to drive domestic demands, and a slower pace of price growth could encourage the FOMC to maintain a zero interest rate policy throughout 2011 as the central bank aims to encourage a sustainable recovery. As a result, if the headline reading for inflation expands less than 2.9%, we will implement the same strategy for a long euro-dollar trade as the short position mentioned above, just in the opposite direction.

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

Period

Data Released

Estimate

Actual

Pips Change

(1 Hour post event )

Pips Change

(End of Day post event)

Mar 2011

04/15/2011 12:30 GMT

2.6%

2.7%

-42

-21

March 2011 U.S. Consumer Price Index

The headline reading for U.S. inflation increased at an annualized pace of 2.7% in March after expanding 2.1% in the previous month, while the core CPI advanced 1.2% during the same period to mark the fastest pace of growth since February 2010. A deeper look at the report showed a 3.5% rise in energy costs, with prices for food advancing 0.7%, while prices for apparel slipped another 0.5% following the 0.9% contraction in February. As price pressures start to emerge, the Federal Reserve may rein in on monetary stimulus, and the central bank may see scope to gradually normalize policy later this year as the economic recovery steadily gathers pace. However, as Fed Chairman Ben Bernanke continues to highlight the ongoing weakness within the private sector, the central bank may retain a zero interest rate policy and support the real economy for most of 2011. The initial reaction to the inflation report was certainly short-lived as the EUR/USD slipped to a low of 1.4390, but the pair recouped some of its losses to close at 1.4422.

EURUSD_Trading_the_U.S._Consumer_Price_Report_body_ScreenShot042.png, EUR/USD: Trading the U.S. Consumer Price Report

Questions? Comments? Join us in the DailyFX Forum

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View the Expo Presentation on ‘Trading the News’ For Additional Resources

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

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12 May 2011 19:52 GMT