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

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

2010-05-18 14:44:00
David Song, Currency Strategist
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Trading the News: U.S. Consumer Price Index

Why Is This Event Important:

As Fed Chairman Ben Bernanke maintains his pledge to keep borrowing costs near zero for an “extended period,” subdued inflation would certainly give the central bank scope to maintain a dovish policy stance in the second-half of 2010, which could lead investors to scale back expectations for a rate hike later this year. However, as the economic recovery gathers pace, heightening price pressures may lead the FOMC to drop its dovish bias for monetary policy and lead the central bank to raise its outlook for growth and inflation.

What’s Expected:
Time of release:        05/19/2010 12:30 GMT, 8:30 EST
Primary Pair Impact :    EURUSD
Expected:         2.4%
Previous:         2.3%

Will This Be Market Moving (Scenarios):

Consumer prices in the U.S. are expected to tip 0.1% higher for the second consecutive month in April, while the headline reading for inflation is projected to expand to an annualized pace of 2.4% from 2.3% in March, which would be the highest reading since January. At the same time, the core CPI is anticipated to fall back to 1.0% from 1.1% in the previous month, and the ongoing slack within the real economy may continue to drag on inflation as households face a weakened labor market paired with tightening credit conditions.

The Upside

As personal spending accelerates in the first-quarter, businesses may look to pass on higher costs to consumers as household confidence continues to recover. At the same time, the Fed said that “the labor market is beginning to improve,” with Kansas City Fed President Thomas Hoenig arguing that “exceptionally low levels of the federal funds rate for an extended period was no longer warranted,” and rising price pressures could certainly lead the FOMC to normalize policy further over the coming months as it aims to balance the risks for the economy

The Downside


However, firms may look to absorb the rise in raw materials as policy makers continue to see ongoing slack within the economy, and a weaker-than-forecast inflation report could weigh on interest rate expectations as the Fed anticipates pressures to remain moderate over the medium term. The MPC said that “economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” and the Fed may look to support the economy throughout the second-half of the year as policy makers aim to encourage a sustainable recovery. 

How To Trade This Event Risk

Higher inflation would certainly limit the central bank’s willingness to maintain a dovish policy stance over the coming months as it maintains its dual mandate to ensure price stability while promoting full-employment, and price action following the release could set the stage for a long dollar trade as investors increase speculation for a rate hike later this year. Therefore, if the headline reading rises to an annualized pace of 2.4% or higher, we will need to see a red, five-minute candle following the data to generate 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 after taking market volatility into account, and this risk will establish 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 market in an effort to lock-in our profits.

On the other hand, the weakness in the labor market paired with the ongoing slack in the real economy may continue to drag on inflation, and a weaker-than-expected CPI report could weigh on the exchange rate as market participants curb expectations for the central bank to tighten monetary policy later this year. As a result, if price growth unexpectedly holds flat or expand at a slower pace from the previous month, we will favor a bearish outlook for the greenback, and will follow the same strategy for a long euro-dollar trade as the short position laid out above, just in reverse.

05.18_TTN1

Impact U.S. Consumer Price Index has had on EUR during the last month

05.18_TTN2

March 2010 U.S. Consumer Price Index

Consumer prices in the world’s largest economy increased 0.1% in March after unexpectedly holding flat in the previous month, while the headline reading for inflation expanded 2.3% from last year amid expectations for a 2.4% rise in price growth. Meanwhile, the core CPI slipped to an annualized pace of 1.1% from 1.3% in February, and subdued inflation would certainly give the central bank scope to maintain a loose policy stance going into the second-half of the year as Fed Chairman Bernanke aims to encourage a sustainable recovery. In the March meeting minutes, Chairman Bernanke maintained his pledged to keep borrowing costs close to zero for an “extended period” given the “slightly greater deceleration in consumer prices,” and went onto say that “a number of participants observed that the moderation in price changes was widespread across many categories of spending.” 05.18_TTN3

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 EUR 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 EUR 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.
 00001_EUR  00002_EUR

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

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