If USD Wants ST Rebound to Become MT Trend, CPI Must Rise
- Higher inflation pressures could cause market to reassess path.
- EUR/USD vulnerable today if US CPI beats - positioning very thin.
- Higher volatility in FX markets should have implications for your trading strategies.
Dissonance has appeared in the market, and it's time to start the resolution process. Federal Reserve policymakers in recent weeks have talked up the possibility of raising rates in June - if the data allowed for it. Market participants, until recent, saw that the data wasn't complying, and as a result, have priced in less than a 10% chance of a Fed rate hike next month.
How quick can the mood change. In two weeks, the US Dollar has gone from down and out to the most resilient major currency. The reversal in the USDOLLAR Index on May 3 has coincided with a resurgence in key US economic data, most notably with last week's April US Advance Retail Sales report. The recent improvement in secondary and tertiary data figures has helped lift the Atlanta Fed's GDPNow Forecast for Q2'16 improved to +2.8%.
The crux of the rate normalization cycle, however, has been inflation. The US labor market is up to snuff for the Fed to raise rates. Even though last month's jobs report was disappointing, it is to be expected that headline NFP figures would moderate as the economy reaches full employment. With the U3 unemployment rate hovering around previously establihsed levels for the Fed's NAIRU, one has to believe that once inflation pressures pick up, the Fed will be incentivized to raise rates quickly.
If you haven't yet, read the Q2'16 Euro Forecast, "EUR/USD Stuck in No-Man’s Land Headed into Q2’16; Don’t Discount ’Brexit’," as well as the rest of all of DailyFX's Q2'16 quarterly forecasts.
--- Written by Christopher Vecchio, Currency Strategist
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