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EUR/USD: Trading the U.S. Consumer Price Index (CPI)

Wed, Nov 19 2008, 05:53 GMT
by Daily FX Research Team

DailyFX

The U.S. dollar could face increased volatility on Wednesday as economists predict the consumer price index to slip to 4.0% from 4.9% in September. In addition, the core measure of inflation is anticipated to follow suit as market participants projected the rate to fall 0.1% in October to 2.4% from 2.5%.

Trading the News: U.S. Consumer Price Index

What’s Expected

Time of release: 11/19/2008 13:30 GMT, 08:30 EST

Primary Pair Impact : EURUSD

Expected: 4.0%

Previous: 4.9%

Impact of the U.S. Consumer Price Index on EURUSD over the last 3 months

September 2008 U.S. Consumer Price Index

The headline reading for inflation fell to 4.9% from 5.4% in August due to a significant decline in oil prices. The breakdown of the report showed that energy costs fell 1.9% as crude oil prices slipped below $75 a barrel, followed by a 0.6% decline in gasoline expenses. Meanwhile, the core measure for inflation held steady at 2.5% for the third consecutive month, which suggests that price pressures may have peaked over the past two months. Lower living costs would certainly help consumers to cope with the slowdown in the economy, and may give the Fed the green-light to lower the benchmark interest rate further over the coming months as the world’s largest economy teeters on the brink of a recession. Moreover, the U.S. dollar may continue to reap the benefits of its safe haven status as the flight to safety continues.

August 2008 U.S. Consumer Price Index

Prices pressures in the U.S. cooled for the first time in nearly two years as the CPI slipped to 5.4% from 5.6% in July. Falling oil prices have certainly helped to limit upside risks for inflation as the core index held steady at 2.5% despite expectations for a 0.1% gain to 2.6%. A deeper look into the report showed that energy costs fell 3.1%, while food prices gained another 0.6% after rising 0.9% in July. Meanwhile, the Fed decided to hold the benchmark interest rate steady at 2.00%, stating that there are ‘significant’ concerns for growth as well as inflation.
However, falling commodity prices have fuel expectations for the central bank to lower the key interest rate in the following months as the downturn in housing and credit sector continues to fuel growth concerns.

July 2008 U.S. Consumer Price Index

The U.S. consumer price index surged to a 17 year high of 5.6% from 5.0% in June on the back of higher food and energy prices. Furthermore, the core measure of inflation ticked higher to 2.5% from 2.4%, indicating that rising commodity prices have fueled upside price pressures in other sectors of the economy. The breakdown of the report showed that food prices increased 0.9%, while energy costs rose 4.0% percent following a 6.6% gain in the previous month. Mounting inflationary concerns have raised speculation that the Fed will target inflation despite the slowdown in the economy, but as oil prices continue to pullback from its record high of $147 a barrel in July, the Fed could be forced to hold a neutral policy stance going forward as they carry out their dual mandate of ensuring price stability while fostering economic growth.

How To Trade This Event Risk

The U.S. dollar could face increased volatility on Wednesday as economists predict the consumer price index to slip to 4.0% from 4.9% in September. In addition, the core measure of inflation is anticipated to follow suit as market participants projected the rate to fall 0.1% in October to 2.4% from 2.5%. The drastic downturn in the economy paired with lower commodity prices led firms to curb their outlook for inflation as the ISM prices paid index slipped to 37.0 from 53.5 in September. Furthermore, fading demands for commodities led the Jefferies/Reuters CRB index to slide to 243.48 after peaking to a high of 473.97 on July 3rd, and demands for commodity may remain subdued for the rest of the year as fears of a global recession intensify. Lower energy costs also led import prices to contract for the third consecutive month in October as the index plunged 4.7% from the previous month to record its biggest decline since 1993. Alleviating price pressures would certainly allow the Fed to remain focused on the downside risks to growth, and may lead the central bank to ease policy further over the coming months in order to avoid a deep and prolonged recession. Meanwhile, Fed Funds Futures are showing that investors are upping the ante for a 50bp cut at the December 16th policy meeting as they project a 98% chance that the FOMC will lower the benchmark interest rate to 0.50%. Lower interest rate expectations could drag on the U.S. dollar as market participants steadily price in a rate cut by the Fed however, the greenback may continue to profit from its safe haven status following the release as the flight to safety continues.

Mounting growth fears have led policymakers to push inflationary concerns to the backburner, but an unexpected spike in prices could lead the Fed to hold a neutral policy stance as price pressures resurface. Therefore, a CPI reading of 5.0% or above paired with an unexpected rise in the core rate would favor a long dollar position (short EURUSD), and we will look for a red, five-minute candle following the release to generate an entry on two lots of the euro-dollar. We will place our initial stop at the nearby swing high (or reasonable distance), and this risk will determine our first target. Our second target will be based on discretion (with a mind to major resistance in the vicinity) and to preserve profit we will move the stop on the second lot to break even when the first half of the trade reaches its target.

Conversely, growth fears have dragged on economic activity throughout the second half of the year, and has certainly helped to taper price pressures throughout the real economy. As a result, a inline print or a headline reading below 4.0% will favor a bearish dollar trade (long EURUSD), and we will follow the same strategy for the short as the long dollar position mentioned above, just in reverse.

Published on  Wed, Nov 19 2008, 06:01 GMT