US CPI Overlooked by Forex, Bond, and Equity Markets

How Did The Markets React?

Though inflation remains one of the hot topics when trading US assets, investors seem to have become more skeptical of the simple ups and downs of headline inflation from month to month. The Consumer Price Index, the final of the three government inflation reads, rebounded in its December measurement with a 0.5 percent pick up in the headline figure for the month. The first showing of positive inflation in four months, last month’s read was also the biggest in eight months. More relevant to monetary policy, the annual gauge had also accelerated to 2.5 percent, notably outside of the Federal Reserve’s 1 to 2 percent comfort zone. However, these numbers no longer gloss the market’s eyes over. Instead, a quick glance to the core figures already reveals underlying inflation has not yet made a convincing turn higher. For the month, consumer inflation, without the influence of volatile products like energy and food, advanced 0.2 percent after marking its first unchanged period in seventeen months in November. The annual figure repeated the previous month’s 2.6 percent print, to halt the three months of contraction. From the details of the Labor Department’s index, there were a few figures drawing the hawks in the crowd, like the 8.0 percent jump in gas and the 0.4 percent rise in housing costs; but the staid numbers elsewhere and expectations for the further withdrawal of energy support come January’s figures left the dollar, treasuries and US equities traders to their own devices.

Bonds – US 10-Year Treasury Note Futures

T-Notes, like its cousin the dollar, reacted quickly to the morning’s CPI numbers, but the cumulative effects of the stable underlying inflation pressures provided little lift for yields. For government debt traders, who try to stay one step ahead of the Fed’s policy whims, the annual figures were of primary importance. However, with headline inflation nowhere near the 3 to 4 percent level seen in the past two years and core not yet turning higher, there was little evidence the Policy Board would overlook its housing and broad economy worries for a hike at its next meeting. Consequently, the possibility of an eventual rate hike once again provided a bid under the note. What’s more, Fed Chairman Bernanke’s refusal to address policy in his Senate testimony allowed the rise to extend through the close.

FX – Euro vs. US Dollar

The dollar saw volatile trading through the morning hours, as a post-CPI rally was quickly erased by a sharp reversal. The chart below shows the extreme nature of these price moves, with the EURUSD briefly piercing the 1.2900 mark before adding over 60 points in the course of an hour. Markets were seemingly taken by surprise by the respectable print, but the dollar bullish move found little foundation as the dust cleared. Indeed, market commentators broadly hailed the CPI release as a sign of slowing price inflation—prompting a more neutral outlook on the future of dollar-linked interest rates. Given recently bullish economic data, expectations for further fundamental news releases have clearly shifted to the upside. This has most notably upped median forecasts for key upcoming figures, with fourth quarter GDP now expected to beat most official predictions.

Implications for the US dollar remain clear; economic data must continue to impress if we are to see a sustained Greenback rally. Subsequent risks arguably remain to the downside through the coming weeks, as any disappointments in US fundamentals could easily trigger retracements of the currency’s recent gains. Furthermore, the recent weakness in equity markets threatens to derail demand for USD-denominated investments, with US stocks down for the second consecutive day on poor outlook for corporate profitability.

Equities – S&P 500 Index Futures

US equities took a tumble on the day, as poor earnings reports and a speech by Fed Chairman Ben Bernanke worsened the outlook for domestic stocks. Traders seemed to take to early economic news well, as S&P 500 futures staged a small-scale rally ahead of the 14:30 GMT (09:30 EDT) market open. Regardless, the relatively low inflation figures were not enough to protect against later developments. Poor earnings reports from key technology firms left stocks broadly weaker, while the bearish results took an especially hard toll on the tech-laden NASDAQ index—down a whopping 1.5 percent through the close. Market bulls hope that equities will be able to stage a respectable retracement through tomorrow’s trade, with a relatively light economic calendar posing little event risks for the world’s largest stock exchanges. Tomorrow’s trade may be particularly important for the NASDAQ index as a whole, as today’s plummet leaves it just 10 points shy of its 50-day moving average at 2433. Technicals show that a break of this support level could have the greater index test a rising 3-month trendline near the 2415 mark.